Finance for Managers: Capital Structure and Payout Policy Analysis, Capital Budgeting

This document provides an analysis of capital structure and payout policy, as well as capital budgeting techniques for finance managers. It includes discussions on historical rates of return, average mean and standard deviation, expected returns, and portfolio beta. The document also covers financial projections for recycling sachet waste and the use of capital budgeting techniques for investment decisions.

ACC91210
Finance for Managers
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Table of Contents
TASK 1............................................................................................................................................3
Capital Structure and Payout Policy Analysis.............................................................................3
TASK 2..........................................................................................................................................12
Capital Budgeting......................................................................................................................12
References......................................................................................................................................25
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TASK 1
Capital Structure and Payout Policy Analysis
1. The historical monthly rates of return for the market index only (monthly rates of return
for the companies are given)
Rate of return of the index
The formula for the calculating the monthly rate of return is change in index value as a
percentage.
In our case we will get the difference between the current month and previous month. We will
express the difference as a percentage of the previous month’s index.
Month Current index Previous index
Monthly
Rates of return
01-Oct 59 483,09
01-Nov 58 149,20 59 483,09 -2,24%
01-Dec 57 887,91 58 149,20 -0,45%
01-Jan 60 199,50 57 887,91 3,99%
01-Feb 63 843,82 60 199,50 6,05%
01-Mar 64 292,24 63 843,82 0,70%
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A. The historical average rate of return and standard deviation of returns
i. Average mean and standard deviation for the case company (BLD).
a. Rate of return for the case company
Rate of return
01-Oct
01-Nov -9,09%
01-Dec -3,14%
01-Jan 0,02%
01-Feb 0,61%
01-Mar -5,22%
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The average mean rate of return is the sum of the rates of return divided by the number of
periods. The sum of the rates of return is -16.82 and the number of periods is 5 months.
Average rate of return = -16.82/5
= -3.36%
Standard deviation is a measure of variability from the expected mean in a population.
The formula is
Standard deviation is 3.56
ii. Average mean and standard deviation for the reference company.
a. Rate of return for the reference company
Month Rate of return
01-Oct
01-Nov 14%
01-Dec 8%
01-Jan 1%
01-Feb -2%
5

01-Mar 3%
Average rate of return = sum of rates of returns /number of periods
= 24/5
= 4.8 %
Standard deviation is 5.64
iii. Average mean and standard deviation for the index
Rates of return for the index
Month Rate of return
01-Oct
01-Nov -2,24%
01-Dec -0,45%
01-Jan 3,99%
01-Feb 6,05%
01-Mar 0,70%
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Average rate of return = sum of rates of returns /number of periods
= 8.06/5
= 1.61%
Standard deviation is 3.01
iv. Average mean and standard deviation for an equally weighted portfolio of the case
company and the reference company
In this case since it an equally weighted portfolio; we will use the arithmetic mean.
Case company average return -3,36%
Reference company average return 4,80%
Average return for the portfolio 0,72%
Case company standard deviation 3,56%
Reference company standard deviation 5,64%
standard deviation for the portfolio 4,60%
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B. Calculate the expected returns and portfolio beta as follows:
i. Capital Asset Pricing Model
1. Expected rate of return for the case company
The formula is:
Expected return = Risk Free Rate + [Beta x Market Return Premium]
Risk free rate 1,65%
Beta 1,26%
Market risk premium 6,50%
Expected return
(1,65+(1,26*6,5) 1,7%
2. Expected rate of return for the reference company
Risk free rate 1,65%
Beta -0,3
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Market risk premium 6,50%
Expected return
1,65+(-0,3*6,5) -0,30%
3. Expected rate of return and beta for the portfolio company
a. Calculation of beta for the portfolio
Beta for the case company 1,26%
Beta for the reference company -0,30%
Beta for the portfolio return
(1,26+-0,30) 0,48%
b. Calculation of expected rate of return for the portfolio
Expected rate of return of the portfolio
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Risk free rate 1,65%
Beta 0,48
Market risk premium 6,50%
Expected return
1,65 + (0,48*6,5) 4,77%
2. Drawing on expectations from theory and incorporating the overall context of your
chosen company, discuss the risk and return measures you have calculated
i. Discussion on risk and return methods
The two methods of determining the risk and rate of return have both merits and demerits.
An analysis of the results from the two methods has given us these results as in the table below.
Weighted Method CAPM
Case company -3,36% 1,73%
Reference company 4,80% -0,30%
Portfolio 0,72% 4,77%
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The weighted rate method is simplistic as it simply gives weight to the rate of return to determine
the expected rate of return (Corporate Finance Institute, 2019). However this is complemented
by analysing the standard deviation which gives us an indication of the volatility of the rates of
return.
In our case, the reference company having a higher rate of return is more volatile and caution
will have to be taken of such a stock is to be bought. The use of historical data may make us
reach wrong conclusions on the current price and future price.
The comparison of the stocks has to be done individually and this may make it less reliable when
doing comparison with the market. However to resolve this, another concept of weighting is
introduced. Assigning the stocks and prices different weights can assist in normalising the
values. This will have the effect of assigning the fair value to each stock and value depending on
the criteria used.
The capital asset pricing method tries to align the returns by comparing this with the
performance of the market. This means that the pricing of the stock is pegged to the risk attached
to it. The benchmark is the risk free rate, which the rate of government bonds is widely used as a
proxy.
The introduction of beta which is measure the stock volatility as compared to the volatility of the
market. This gives us a value that is aligned to the market. Investors basically want to have a
return higher than the set risk free rate. This is compensation for the time taken in holding the
stock and risk.
However this method relies on assumptions of fixed interest rates for government bonds,
predictable investor behaviours and market fundamentals. However it remains a realistic tool for
estimating if a stock is fairly valued (Mackaya and Haque, 2016).
The two methods try to predict the return of a stock. However other factors also affect the pricing
of stocks and subsequent expected returns. Total return consists of two components, income
stream investment which provides a performance measure focusing on an income stream on an
asset. The second is the coupon and dividend yield where investors are provided with useful
information but the components may be changed due to change in assets i.e. capital gain or
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capital loss which some may have zero bonds where shares do not pay any dividends (Filatova,
2018).
TASK 2
Capital Budgeting
MEMO
To: The CEO
From: Finance Manager
Subject: Financial Projections for recycling sachet waste
The environmental impact of plastic waste is reduce by producing recycled plastic which does
not have adverse impact on profit of the company and it also enhances the goodwill of the
company in the competitive market. While introducing this innovation in the company some
research and development program has been done by the R&D department which provides some
useful benefits of recycling the plastic waste. The main plan is to replace the use of virgin plastic
in packaging which reduces the cost and enhances the profit margin for the company. The
finance department has some estimation regarding the packaging cost based on virgin plastic
which is expected to increase by 2% per year after year which adverse effect on the company’s
profit margin. The recent variable plastic packaging costs is $27 million which has been
increasing per year. If the company recycles the sachet plastic which used in packaging the
products reduces the following two points which are mentioned below:
 Firstly, it will reduce costs compared to production of virgin plastic and this projection
also reduces the annual forecast cost of packaging by 10%
 Secondly, a virgin plastic supplier margin which is equal to 8% of annual forecast
packaging costs will be reduced. This benefit is expected to be offset by a new cost
associated with paying a partner to supply plastic waste raw material for recycling.
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This new innovation is the life saver for the company and also provides benefits associated to
cost savings. The sales and marketing managers have argued that if company introduces this plan
in their business operations, the sales will increase due to demand for environmentally
responsible products by customers. The environmentally responsible products have following
benefits which are stated below:
 It will reduce the demand in the market for products.
 It will also enhances sales revenue and profit margin
 It also improves goodwill in the competitive market
 It will also increases the customers for their products
 Stakeholders will also like to invest the money in the company’s business operations
Figure: Annual Australian plastics recycling 2000 to 2016-17
Source: (Sengul, Costa, and Gimeno, 2019)
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In 2016-17 overall plastics consumption
Now a days a plastic consumption is through finished and semi-finished goods is about 66%,
with only 34% of consumption through locally processed recycle based resins or local
manufacturing using either virgin resins (Abor, 2017).
Financial Analysis
The financial analysis can be done with the help of Capital Budgeting technique which provides
accurate information about whether the project is feasible for the company’s business operations
or not (Thambar, Brown, and Sivabalan, 2019).
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Decisions of Investment
Capital Budgeting
Techniques:
 Pay- back period
 Net Present Value
 Internal Rate of
Return
 Accounting Rate of
Return
 Discounted Pay-
back period
Types of Investment
Decisions
Basic Principles for
measuring Project Cash
flows
Capital budgeting in special
cases like whether purchase
new machine or not

Figure: Investment decision
By Author, 2019
The Capital budgeting involves:
 Identification of investment projects that are strategic to business overall objectives;
 Evaluating and estimating post-tax incremental cash flows for each of the investment
proposals; and
 Selection an investment proposal that maximizes the return to the investors.
Figure: Types of Capital Investment Decisions
By Author, 2019
Following methods are used to take investment decisions in proposed project which are listed
below:
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Types of Capital
Investment Decisions
On the basis of firm's
existence
Modernisation and
Replacement
Decisions
Diversification
Decisions
Expansion Decisions
On the basis of decision
situation
Accept - Reject
Decisions
Mutually exclusive
Decisons
Contingent Decisions

 Pay-back period
 Net present value
 Internal rate of return
These methods above method give an idea to the company whether they have to invest in the
proposed project or not.
I. Pay- back period
The payback period helps the top management to find out in how much period of time the
company recovers the total net cash from the investment. In other words, this method tells to the
investors in how much time they recovered the money from the project (Mendes-Da-Silva and
Saito, 2019).
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Calculation of Cash inflow from proposed project
Particulars Year
1
(In
Million)
Year
2
(In
Million)
Year
3
(In
Million)
Year
4
(In
Million)
Year
5
(In
Million)
Year
6
(In
Million)
Sales 550
(440*2.5%)
561 572 584 595 607
Less:
Depreciatio
n
4.75 4.75 4.75 4.75 4.75 4.75
Profit before
tax but after
depreciation
545.25 556.25 567.25 579.25 590.25 602.25
Less: Tax @
30%
163.575 166.875 170.175 173.775 177.075 180.675
Profit after
tax
381.675 389.375 397.075 405.475 413.175 421.575
Add:
Depreciatio
4.75 4.75 4.75 4.75 4.75 4.75
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n
Cash Flow 376.925 384.625 392.325 400.725 408.425 416.825
Working Note:
1. Sales
Year 1: 440*2.5% = $550 million
Year 2 to 6: 440*2% increment in each year
2. Depreciation
= $30 - $1.5/6 = $4.75
Calculation of initial cost of proposed project
Initial Costs
Amount (In
Million)
Plant & Equipment $30
Research & Development $25
Packaging Cost 22.14
Marketing Cost 13
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Administrative & general expenses 4
Interest expenses 1.2
Working Capital ($440*1%) 4.4
Cash Outflow $100
Payback period shall be calculated by using cumulative cash flows as follows
Year Annual Cash Inflows Cumulative Cash Inflows
1 376.925 376.925
2 384.625 761.55
3 392.325 1153.875
4 400.725 1554.6
5 408.425 1963.025
6 416.825 2379.85
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Therefore, the company recovers $100 million in the first year. The company should accept the
project which provides future benefit to the company.
II. Net Present Value
The net present value method uses a discount rate which is specified by the company to bring all
following net cash inflows after the initial investment to their present values (Srithongrung,
Yusuf, and Kriz, 2019).
Decision rule:
If NPV ≤ 0, Reject the proposal
If NPV ≥ 0, Accept the proposal
Calculation of discounted cash flows for the proposed project
Year Cash flow PVIF @ 9% Discounted Cash Flows
1 376.925 0.917431193 345.8027523
2 384.625 0.841679993 323.7311674
3 392.325 0.77218348 302.9468838
4 400.725 0.708425211 283.8836927
5 408.425 0.649931386 265.4482264
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6 416.825 0.596267327 248.5391285
Discounted cash
flows 1770.351851
Calculation of initial cost of proposed project
Initial Costs
Amount (In
Million)
Plant & Equipment $30
Research & Development $25
Packaging Cost 22.14
Marketing Cost 13
Administrative & general expenses 4
Interest expenses 1.2
Working Capital ($440*1%) 4.4
Cash Outflow $100
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Net present value = Discounted cash flows – total net initial investment
= $1770.352 - $100
= $1670.352
The net present value is positive and after deducting the total net initial investment from the
discounted cash flows, the company will incur the profit which shows that if they launch
proposed project they will be in profit (Kengatharan, 2016).
III. Internal rate of return
It is the discount rate that links the present value of the expected net cash flows with the initial
cash outflow (Turner and Coote, 2018).
It is calculated by using below formulae:
IRR = LR + NPV at LR/ NPV at LR – NPV at HR x (HR – LR)
Let assume that LR = 9%
And HR = 10%
Calculation of discounted cash flows by 9%
Year Cash flow PVIF @ 9% Discounted Cash Flows
1 376.925 0.917431193 345.8027523
2 384.625 0.841679993 323.7311674
3 392.325 0.77218348 302.9468838
4 400.725 0.708425211 283.8836927
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5 408.425 0.649931386 265.4482264
6 416.825 0.596267327 248.5391285
Discounted cash
flows 1770.351851
Calculation of discounted cash flows by 10%
Year Cash flow PVIF @ 10%
Discounted Cash
Flows
1 376.925 0.909090909 342.6590909
2 384.625 0.826446281 317.8719008
3 392.325 0.751314801 294.7595793
4 400.725 0.683013455 273.7005669
5 408.425 0.620921323 253.5997914
6 416.825 0.56447393 235.2868459
Discounted cash
flows 1717.877775
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IRR = [9 + (1770.352 – 1717.878)/ (1770.352 – 100)] x 10- 9
= 9.031%
Internal rate of return is according to the estimation which provides desired return from proposed
investment to the company. So, the company should accept the project.
Recommendation: By using the above main methods of capital budgeting it concluded that the
company should work in the proposed project which provides future benefits in the form of
monetary and non- monetary benefits (Lane and Rosewall, 2015).
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References
Abor, J.Y., 2017. Evaluating Capital Investment Decisions: Capital Budgeting.
In Entrepreneurial Finance for MSMEs (pp. 293-320). Palgrave Macmillan, Cham.
Corporate Finance Institute. 2019. Expected Return - How to Calculate a Portfolio's Expected
Return. https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/expected-
return/
Filatova, T., 2018. Modern Corporate Finance: New Approaches and Decisions. Journal of
Reviews on Global Economics, 7, pp.i-vi..
Kengatharan, L., 2016. Capital budgeting theory and practice: a review and agenda for future
research. Applied Economics and Finance, 3(2), pp.15-38.
Lane, K. and Rosewall, T., 2015. Firms’ investment decisions and interest rates. Reserve Bank of
Australia Bulletin. June quarter, pp.1-7.
Mackaya, W. and Haque, T., 2016. A study of industry cost of equity in Australia using the
Fama and French 5 Factor model and the Capital Asset Pricing Model (CAPM): A
pitch. Accounting and Management Information Systems, 15(3), p.618.
Mendes-Da-Silva, W. and Saito, R., 2019. Stock Exchange Listing and Capital Budgeting
Practices. In Individual Behaviors and Technologies for Financial Innovations (pp. 363-383).
Springer, Cham.
Sengul, M., Costa, A.A. and Gimeno, J., 2019. The Allocation of Capital within Firms. Academy
of Management Annals, 13(1), pp.43-83.
Srithongrung, A., Yusuf, J.E.W. and Kriz, K.A., 2019. A systematic public capital management
and budgeting process. In Capital management and budgeting in the public sector (pp. 1-22). IGI
Global.
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Thambar, P.J., Brown, D.A. and Sivabalan, P., 2019. Managing systemic uncertainty: The role of
industry-level management controls and hybrids. Accounting, Organizations and Society.
Turner, M.J. and Coote, L.V., 2018. Incentives and monitoring: impact on the financial and non-
financial orientation of capital budgeting. Meditari Accountancy Research, 26(1), pp.122-144.
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