APC 308 Financial Management Assessment 2019

This document provides solutions for APC 308 Financial Management Assessment 2019. It includes the calculation of book value and market value cost of capital, cost of capital of company as per the new structure, and minimizing the cost of capital using gearing in the capital structure. The document also discusses the effects of short-termism on bankruptcy and the agency problem in a company. The solutions are supported with relevant academic research.

APC 308 FINANCIAL
MANAGEMENT ASSESSMENT 2019

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Question 1........................................................................................................................................1
a) Calculation of Book Value and Market value cost of Capital (WACC) for Kadlex plc.........1
b) Cost of Capital of company as per the new structure of Kadlex plc......................................5
c) Minimising the cost of capital using gearing in the capital structure.....................................9
(d) Critically evaluate the effects of short-termism on bankruptcy and the agency problem in a
company, ensuring the response is supported with relevant academic research.........................9
Question 2......................................................................................................................................10
1 & 2 Number of Shares to be issued and theoretical ex right price.........................................10
3. Calculating expected value of earnings per share.................................................................11
4&5. form of an issue for price of each right issue & Presenting all the three options of the
right issue in the tabular form...................................................................................................11
©Advantage of scrip dividend for shareholders and company.................................................13
Question 3......................................................................................................................................13
(a)Project evaluation methods...................................................................................................13
(b) Critically evaluate the benefits and limitations of each of the differing investment
appraisal techniques..................................................................................................................15
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................................17
Table 1Weighted Average Cost of Capital......................................................................................1
Table 2Cost of equity.......................................................................................................................2
Table 3Cost of Preference Share Capital (Kp)................................................................................2
Table 4Cost of Debt (Kd)................................................................................................................3
Table 5Capital Structure of Kadlex as on 31 December 2017........................................................3
Table 6Total Value of Debt and Equity...........................................................................................4
Table 7Calculation of Weights........................................................................................................4
Table 8Weighted average cost of capital.........................................................................................5

Table 9Cost of Equity (Ke)..............................................................................................................5
Table 10Cost of Preference Share Capital (kp)...............................................................................6
Table 11Cost of Debt (kd)...............................................................................................................6
Table 12Capital structure.................................................................................................................7
Table 13Total Capital......................................................................................................................7
Table 14Calculation of Weights......................................................................................................8
Table 15New share issue and theoretical ex share price...............................................................10
Table 16Earning per share (EPS)..................................................................................................11
Table 17Ex- rights value per share................................................................................................11
Table 18Ex- rights value per share................................................................................................11
Table 19Ex- rights value per share................................................................................................12
Table 20Calculation of depreciation..............................................................................................13
Table 21Payback period................................................................................................................13
Table 22Calculation of ARR.........................................................................................................14
Table 23Calculation of NPV.........................................................................................................14
Table 24Calculation of IRR...........................................................................................................15

INTRODUCTION
Finance management is the one of the area which greatly impact business firm. In the
current research study detail investigation is carried out on the WACC, right issue of shares and
cost of capital. Discussion is carried out on capital restructuring that must be done in order to
reduce cost of capital in the business. At end of the report, project evaluation technique is used
and evaluation of project is done as well as viability is measured. In this way, entire research
work is carried out.
Question 1
a) Calculation of Book Value and Market value cost of Capital (WACC) for Kadlex plc.
Weighted Average Cost of Capital as per book value and Market Value.
Table 1Weighted Average Cost of Capital
Weighted Average Cost of Capital
As per Book Value
Value Weight Cost Weight*Cost
Value of Equity 20000 44.44% 53.60% 23.82%
Value of BOND 15000 33.33% 7.00% 2.33%
Value of Preference share 10000 22.22% 7.00% 1.56%
Total Capital 45000 100.00% 67.60% 27.71%
As per Market Value
Value Weight Cost Weight*Cost
Value of Equity 20000 44.44% 53.60% 23.82%
Value of BOND 15000 20.97% 7.00% 1.47%
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Value of Preference share 10000 9.80% 9.33% 0.91%
Total Capital 45000 100.00% 49.01% 25.01%
Cost of Capital
Table 2Cost of equity
Book Value
Market
Value
0 Year 1 Year
Expected dividend 0.28 0.336 0.336
Current stock price 1 2.65
Growth Rate 20.00% 20.00%
Cost of equity
= Expected Dividend
in 1 year ÷ Current
Stock Price + Growth
Rate
Cost of Equity 53.60% 32.68%
Table 3Cost of Preference Share Capital (Kp)
Cost of Preference
Capital
Book Value Market Value
Dividend per share 0.07 0.07
Net proceeds 1 0.75
Cost of Preference
Share Capital 7.00% 9.33%
2

Table 4Cost of Debt (Kd)
Cost of debt 10.00%
After tax debt (1 – 30%)
Cost of debt 7.00%
Table 5Capital Structure of Kadlex as on 31 December 2017
Capital Structure
Book Value Market Value
Current Value of Equity
Number of shares 20000 20000
Price per share 1 2.65
Value of Equity 20000 53000
Current Value of Debt
Number of Bonds 150 150
Price per bond 100 107
Value of BOND 15000 16050
Current Value of
Preference Capital
Number of Preference Shares 10000 10000
3

Price per share 1 0.75
Value of Preference share 10000 7500
Table 6Total Value of Debt and Equity
Total Value of Debt and
Equity
Book Value Market Value
Value of Equity 20000 53000
Value of BOND 15000 16050
Value of Preference share 10000 7500
Total Capital 45000 76550
Table 7Calculation of Weights
Weights
Book Value Market Value
Weight of Equity
Equity 20000 53000
Total Capital 45000 76550
Weight 44.44% 69.24%
Weight of Preference
Capital
Preference Capital 10000 7500
Total Capital 45000 76550
Weight 22.22% 9.80%
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Weight of Debt
Debt 15000 16050
Total Capital 45000 76550
Weight 33.33% 20.97%
b) Cost of Capital of company as per the new structure of Kadlex plc
Table 8Weighted average cost of capital
Weighted Average Cost of Capital
Book Value Value Weight Cost Weight*Cost
Value of Equity 57000 72.34% 31.79% 22.99%
Value of BOND 15000 19.04% 8.00% 1.52%
Value of Preference share 6800 8.63% 10.29% 0.89%
Total Capital 78800 100.00% 50.08% 25.41%
Cost of Capital
Table 9Cost of Equity (Ke)
Cost of Equity
Expected dividend 0.336
Current stock price 2.85
Growth Rate 20.00%
Cost of equity = Expected
Dividend in 1 year ÷
Current Stock Price +
Growth Rate
5

Cost of Equity 31.79%
Table 10Cost of Preference Share Capital (kp)
Cost of Preference
Capital
Dividend per share 0.07
Net proceeds after selling 0.68
Cost of Preference Share
Capital 10.29%
Cost of Debt (kd)
Table 11Cost of Debt (kd)
Cost of debt
Maturity Period 7
Par Value 100
Net
proceeds(Par+Premium) 105
I 11
Premium 5
Mp 7
I+(premium/Mp) 11.71
P 100
np 105
P+np/2 102.5
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Tax Rate (1-0.3) 0.7
Cost of Debt Capital 11.43%
After tax debt 8.00%
Capital Structure of Company of company under the proposed new plans
Table 12Capital structure
Value of Equity
Number of shares 20000
Price per share 2.85
Value of Equity 57000
Value of Debt 15000
Value of Preference
share
Number of Preference
Shares 10000
Price per share 0.68
Value of Preference
share 6800
Table 13Total Capital
Total Value of Debt and
Equity
Value of Equity 57000
7

Value of Debt 15000
Value of Preference share 6800
Total Capital 78800
Calculation of Weights
Table 14Calculation of Weights
Weight of Equity
Equity 57000
Total Capital 78800
Weight 72.34%
Weight of Preference
Capital
Preference Capital 6800
Total Capital 78800
Weight 8.63%
Weight of Debt
Debt 15000
Total Capital 78800
Weight 19.04%
Recommendations over the projections of finance director
As per given information it is clear that the finance directors intend to cut cost of capital by
issuing new debts. This will change the capital structure. It is well known fact that cost of debt is
lower than same of equity and due to this reason if debt is issued then in that case cost may
decline (Shapiro and Hanouna, 2019). The cos of debt will be increased to 11% from 10%.
Business firm will buy back its shares from the available cash amount and this will increase
share price to £2.85. It can be observed that based on new projections overall cost of capital will
be 25.41% which actually is lower than the present book value cost of capital but higher than the
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market value cost of capital. Therefore, the projections made by finance manager should be
adopted as it will increase the share value by reducing the cost of capital of company.
c) Minimising the cost of capital using gearing in the capital structure
Cost of the capital is the one of the main focal point of the most business firms. This is
because if cost of capital is high then in that case business firm have to pay more to banks and
other financial institutions. Thus, it can be said that cost of capital creates extra payment burden
on the business firm. Thus, main focus of manager always remains on reducing cost of capital in
the business. In order to reduce capital structure many business firms focus on reducing equity
and increasing debt (Finkler, Smith and Calabrese, 2018). This is known as capital restructuring.
Many times, when capital structure become imbalanced business firms restructure their capital
structure. It is well known fact that cost of debt is relatively lower then same of equity. This is
because equity shareholders are considered as real owner of the company and due to this reason
high rate is paid to them relative to interest rate on debt. Cost of debt refers to the interest that is
charged by the banks on loan amount that is taken by the firm from it. Interest paid on
debentures and corporate bond is also considered as cost of debt. Cost of debt is always lower
then cost of equity and due to this reason always it is suggested that portion of equity in the
capital structure must be low and portion of debt must be high so that cost of finance can be
controlled in the business (Renz. and Herman, 2016). However, this does not mean that firm
consistently increase bank loan or other debt instruments at fast rate in its business. This is
because many times it happened that debt burden increase in the business out of tolerable limit
and cost of debt rose sharply. Hence, firm take debt from the market only to certain level.
(d) Critically evaluate the effects of short-termism on bankruptcy and the agency problem in a
company, ensuring the response is supported with relevant academic research.
Short termism refers to the situation where firm focus on short term gain or opportunity at
the expense of the long-term opportunity of gain. Firms mainly do this when they are extremely
on pressure or competition is fierce. Many times, due to cut throat competition firms earn less
profit in their business and to ensure survival and sustainability they make efforts to earn profit
for short term. Hence, in order to earn short term profit business firm, make change in its
business operations which can be not be considered good from long term time period. If any
company is operating in mobile phone manufacturing business and face loss then it may focus on
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market expansion. If there is less liquidity in the business then firm can decide to cut its research
and development expenditure in its business. Ultimately, firm will lag behind in competition in
long term. Hence, in this way short termism negatively affect business.
Layman brother and Merrill Lynch become bankrupt because they in order to make short
term gain consistently give home loans. When market conditions get changed people become
unable to pay loan amount and due to this reason both banks consistently face loss in the
business (Karadag, 2015). Ultimately, both banks become bankrupt. Thus, it can be said that
short termism has negative consequences for the business firms.
Agency is the legal term which means that there is individual who act as agent of the
principal. In respect to the company shareholders are principal and employees are there agent. As
agent have power to take decision on behalf of the principal. Many times, it happened that
managers are agent and they have to work towards satisfaction of needs and wants of the
shareholders but they work towards fulfilment of their own interest (Barr and McClellan, 2018).
On this point conflict arises between management and shareholders. In order to solve problem
some provisions must be made at the workplace that address interest of management in proper
manner. By doing so problem can be reduced to great extent.
Question 2
Long term: Equity finance
1 & 2 Number of Shares to be issued and theoretical ex right price
Table 15New share issue and theoretical ex share price
Particulars Right issue prices
At 1.80 At 1.60 At 1.40
Funds to be issued 180000 180000 180000
Number of shares to be issued 100000 112500 128571
New share after right issue 700000 712500 728571
Current market price 1.9 1.9 1.9
Rights issue share price 1.8 1.6 1.4
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Theoretical ex-share price 1.89 1.88 1.88
3. Calculating expected value of earnings per share
Table 16Earning per share (EPS)
Particulars Right issue prices
At 1.80 At 1.60 At 1.40
Total shareholders fund 880000 880000 880000
Net Profit after tax @ 20% of
shareholders fund 176000 176000 176000
New share after right issue 700000 712500 728571
Expected Earning Price Per Share 0.251 0.247 0.242
4&5. form of an issue for price of each right issue & Presenting all the three options of the right
issue in the tabular form
Table 17Ex- rights value per share
Particulars Right issue price at 1.80
600000 ordinary shares at 0.50 p 300000
100000 new shares at 1.80 180000
Value of 700000 shares 480000
Ex- rights value per share 0.686
Table 18Ex- rights value per share
Particulars Right issue price at 1.60
600000 ordinary shares at 0.50 p 300000
112500 new shares at 1.60 180000
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Value of 712500 shares 480000
Ex- rights value per share 0.674
Table 19Ex- rights value per share
Particulars Right issue price at 1.40
600000 ordinary shares at 0.50 p 300000
128571 new shares at 1.80 180000
Value of 728571 shares 480000
Ex- rights value per share 0.659
Right issue is the one of the common term under which any company if launch shares in the
share market then in that case it first of all offer issue to the existing shareholders and then to
general public. Main advantage of the right issue for existing shareholders is that they get shares
at discounted price rate or at cheaper rate. In a right issue existing shareholder can purchase the
shares of company at a discounted price than that is available in the market to general public
(Zietlow and et.al., 2018). Thus, it can be said that if shareholders sold those shares in market
then they earn good amount of capital gain. Main aim behind right issue is to obtain more and
more capital in the business so that enough liquidity remains in the business in respect to the
finance of the business project.
In the current scenario company decide to issue right issue so that maximum capital can be
obtained from the investors. Management have three options or prices at which shares can be
issue through right issue to the shareholders. It is well known fact that during right issue share
price decline and due to this reason shares must be issued at price that least affect shareholders
(Burtonshaw-Gunn, 2017). Company shall issue right shares at £1.80 as it will prove beneficial
for the shareholders. More right issue will be made at low price share price will be declined in
the market. Hence, it will be better to offer less discount on right issue.
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©Advantage of scrip dividend for shareholders and company
Dividend refers to the return that shareholders receive on making investment in the
company. Every year at end of the financial year company declare dividend amount that will be
paid to the shareholders. Dividend are of two types cash dividend and scrip dividend. Cash
dividend refers to the dividend that is paid solely on cash. On other hand, scrip dividend means
an option under which shareholder if intend can receive cash dividend or shares equal to value of
cash dividend (Banerjee, 2015). There is advantage of scrip dividend to both company and
shareholders. Major benefit to shareholders is that they can either choose to receive cash or
shares. If investor is old age individual it can opt for cash. On other hand, if investor is young
then it can opt for stocks and by selling those stocks in the market it can earn large amount of
money to finance its needs. For company main advantage of issuing scrip dividend is that if more
shareholders decide to opt for shares then it will not need to pay cash and can save money and
can invest same in business which will lead to good amount return generation for shareholders
and company. Thus, it can be said that scrip dividend is beneficial for both shareholders and
company.
Question 3
(a)Project evaluation methods
Table 20Calculation of depreciation
Asset cost 275000
Useful life in years 6
Salvage value 41250
Depreciation 38958
Table 21Payback period
Initial investment -275000
Year
Cash flows (IN-
OUT)
1 72500 -202500
2 72500 -130000
13

3 72500 -57500
4 72500 15000
5 72500 87500
6 72500 160000
Project total life is 6 years and it is covering investment amount in three years just half of its life.
On this basis, it can be said that project is viable for the business firm.
Table 22Calculation of ARR
Year
Cash flows (IN-
OUT) Depreciation
Net cash
flow
1 72500 38958 33542
2 72500 38958 33542
3 72500 38958 33542
4 72500 38958 33542
5 72500 38958 33542
6 72500 38958 33542
Average 33542
Initial
investment 275000
ARR 12%
ARR of the project is 12% which can be considered moderate and on this basis, it can be said
that project is not viable for the firm.
Table 23Calculation of NPV
Yea
r
Cash flows (IN-
OUT)
Depreciatio
n
Net cash
flow
Net cash flow*(1-tax
rate)
Final cash
flow
(Addition of
depreciation
)
1 72500 38958 33542 27169 66127
2 72500 38958 33542 27169 66127
3 72500 38958 33542 27169 66127
14

4 72500 38958 33542 27169 66127
5 72500 38958 33542 27169 66127
6 72500 38958 33542 27169 66127
SUM 396763
Initial investment 275000
NPV 121763
Net present value is positive and large which reflect that overall project is profitable in nature
and due to this reason investment must be made on it.
Table 24Calculation of IRR
Year -275000
1 72500
2 72500
3 72500
4 72500
5 72500
6 72500
IRR 15%
IRR reflect actual return that can be gained on making investment. IRR of project is 15%
which reflect that project is profitable and investment must be made on the project.
(b) Critically evaluate the benefits and limitations of each of the differing investment appraisal
techniques
Payback period
Payback period is the tool which reflect duration within which investment amount can be
covered (Matthew., 2017). Main advantage of payback period is that it is easy to apply this
method. Disadvantage is that present value method is not used to evaluate project profitability.
Average rate of return
Average rate of return is the method that reflect average return that can be gained on the
project. Main advantage of this method is that it indicates mean return that can be expected on
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the project. Limitation of ARR method is that it does not take in to account concept of time value
of money.
Net present value
Net present value method reflects the net value of the project. Advantage of NPV method
is that it reflects value of the project that remain after deducting all expenses from cash revenue
(Pandey., 2015). Disadvantage of NPV method that its calculation process is complex and non-
technical person cannot do calculation.
IRR
IRR is the method which reflect actual return that can be gain on the project (Internal
rate of return, meaning formula and usage., 2019). Advantage is that it gives more accurate
overview of the project then ARR. Disadvantage is that calculation process is complex.
CONCLUSION
On the basis of above discussion, it is concluded that firms must time to time evaluate
their capital structure and if required must do its restructuring. In this regard, they can reduce or
increase debt or equity in the capital structure. Large proportion of debt then equity lead to low
WACC. It is also concluded that firm must right issue shares because it is beneficial for it and
shareholders. Project evaluation approaches must be used to identify viability of the project.
There are some merits and demerits of project evaluation methods and due to this reason
multiple approaches must be used to evaluate project.
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REFERENCES
Books and Journals
Banerjee, B., 2015. Fundamentals of financial management. PHI Learning Pvt. Ltd..
Barr, M.J. and McClellan, G.S., 2018. Budgets and financial management in higher education.
John Wiley & Sons.
Burtonshaw-Gunn, S.A., 2017. Risk and financial management in construction. Routledge.
Finkler, S.A., Smith, D.L. and Calabrese, T.D., 2018. Financial management for public, health,
and not-for-profit organizations. CQ Press.
Karadag, H., 2015. Financial management challenges in small and medium-sized enterprises: A
strategic management approach. EMAJ: Emerging Markets Journal, 5(1), pp.26-40.
Matthew, B.T., 2017. Financial management in the sport industry. Routledge.
Pandey, I.M., 2015. Essentials of Financial Management, 4th Edtion. Vikas publishing house.
Renz, D.O. and Herman, R.D. eds., 2016. The Jossey-Bass handbook of nonprofit leadership and
management. John Wiley & Sons.
Shapiro, A.C. and Hanouna, P., 2019. Multinational financial management. Wiley.
Zietlow, J., Hankin, J.A., Seidner, A. and O'Brien, T., 2018. Financial management for nonprofit
organizations: policies and practices. John Wiley & Sons.
Online
Internal rate of return, meaning formula and usage., 2019. [Online]. Available through;<
https://cleartax.in/s/internal-rate-of-return-irr>.
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