Financial Management: Long Term Finance and Investment Appraisal Techniques

This document provides an overview of financial management, focusing on long term finance and investment appraisal techniques. It discusses the benefits of scrip dividend for shareholders and companies. The document also explores the payback period and accounting rate of return as investment appraisal techniques.

Financial
Management

Table of Contents
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
QUESTION 2...................................................................................................................................1
(a) Long term finance: Equity finance........................................................................................1
(c) Evaluate the benefits of scrip divided in context of shareholders or companies...................4
QUESTION 3...................................................................................................................................5
a. Investment appraisal technique...............................................................................................5
b. Critical evaluation of investment appraisal techniques with the help of its benefits &
drawbacks....................................................................................................................................9
CONCLUSION..............................................................................................................................11
REFERENCES .............................................................................................................................12

INTRODUCTION
In the current business atmosphere, it is recognized as financial management to handle
and monitor each financial event over a specified period of time. There's a necessity to monitor
and allocate fiscal resources across every form of enterprise in attempt to perform out the
intended operation in most efficient way to enhance the overall profits. This is categorized as a
sort of tactics best linked to financial practices, planning, leadership and strategic planning. It
emphasizes simply on percentage growth and obligations as it makes it possible to efficiently
manage the strategic plan. Furthermore, all forms of businesses require this to manage the
funding and financial resources (Shapiro and Hanouna, 2019).
Key strategic decisions are being made in this study to render critically important
decisions, crucial comprehension of specific analytical skills are discussed to make decisions at
international scale. Furthermore, constraints of the present state regarding financial theories are
developed which make much better business decisions.
MAIN BODY
QUESTION 2
(a) Long term finance: Equity finance.
(A) Issue of Right share: Rights issue implies to offering of rights to company's current
shareholders which allows them to purchase added securities directly from corporation at a
discounted rate instead of buy shares on secondary market. The total of extra securities to be
purchased relies on the shareholders ' existing holdings. Rights issue offers present shareholders
preferential attention where they have the legal ability like right (not the ethical responsibility) to
buy shares at cheaper price before or on a specific date (Brigham and Houston, 2012). Here in
this context Lexbel plc wants to issue right shares among existing shareholders with aim to fulfil
their funding requirements. In this context following are calculations to assess the number of
right share that company can issue based on their existing profits and capital structure, as
follows:
Lexbel plc wishes to rise: 180000GBP
Current ex-dividend market-price of Lexbel plc: 1.90GBP
3 assorted rights-issue prices recommended by corporation's finance director: GBP1.80,
GBP1.60 and GBP1.40
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Right issue of Lexbel plc
Aggregate (no.)Ordinary shares ( @ 50 for
each) 300000 Pounds
Add: Aggregate Reserve 400000 Pounds
Whole Sum 700000 Pounds
Profit Post taxation ( 700000 pounds x 20
percent) 140000 Pounds
(I) Number of shares to be issued = (Aggregate Funds to be elevated / right issue prices)
Descriptions
Amount (in
pound except
shares)
Amount (in
pound except
shares)
Amount (in pound
except shares)
Exist number of share 600000 600000 600000
Fund to be raised (A) 180000 180000 180000
Suggested right issue prices (B) 1.8 1.6 1.4
Number of shares to be issued: 1/2 100000 112500 128571
(ii) Theoretical ex price:
Theoretical ex-rights price shows valuation of securities provided by an offer of specific
rights. Usually, selling rights is only open to existing shareholders and that only accessible for
short period of time (around 30 days). Rights deals typically provide shareholders with the
alternative of buying a proportionate number of shares at discounted-rate, pre-specified price.
The component to be acquired by each shareholder is focused on the existing stakes in the
company of shareholders. The aim is to generate extra capital with existing stakeholders being
given priority (Karadag, 2015). Offers of security rights could be a common occurrence for
investors including investors because they can generate future grounds for arbitration through the
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time of rights offered. Generally, rights offering duration will inhibit competitive market dealing
even more as it sets a precedent over current stock price.
Particulars Condition (i) Condition (ii) Condition (iii)
Recommended right issue prices 1.8pound 1.6pound 1.4pound
Fund to be raised 180000 pounds
180000
pounds
180000
pounds
Number of shares needed to issue 1 lac shares
1.125 lac
shares
128571.43shar
es
Pre right issue 1140000 1140000 1140000
Post right issue 1320000 1320000 1320000
Theoretical ex-right price 1.89 1.85 1.81
(iii)
Anticipated earning per share (EPS) = (Shares before right issue x theoretical ex- right price) /
Current market price, so here in given case Market rate is 1.9 and Available(no.) of shares are
600000shares while Return on shareholder fund is 140000pounds
Particulars Amount (in £) Amount (in £) Amount (in £)
Suggested right issue prices £1.8 £1.6 £1.4
Fund to be raised 180000 180000 180000
Number of shares needed to issue 100000 112500 128571.43
Pre right issue 1140000 1140000 1140000
Post right issue 1320000 1320000 1320000
Theoretical ex-right price 1.89 1.85 1.81
One right value 0.01 0.05 0.09
Fair value of each share 95238.1 97297.3 99447.51
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Bonus fraction 50390.53 52593.14 54943.38
Expected earning per share (EPS) GBP 1.8 GBP 1.6 GBP 1.4
(iv) Form of issue of right issue price:
Particulars Amount (in £) Amount (in £) Amount (in £)
Suggested right issue prices 1.8 1.6 1.4
Fund to be raised 180000 180000 180000
Number of shares to be issued: 100000 112500 128571.43
Exist number of share 600000 600000 600000
Ratio of new-shares to existing-share 24.14% 24.70% 24.16%
Issue proportion of right shares holding
by existing shareholders
Issue of 1 :for 6
right shares held
Issue of 9 :for
48 right shares
held
Issue of 3 :for
14 right shares
held
Critical evaluation:
From above table's interpretation it has been evaluated that there are following three situation in
context of Issue of right shares with three alternatives, as shown below:
 The no. of operationally enriched securities throughout right issue of alternative rate of
1.80 will be 1 lac shares of each share. Shareholders should therefore assign the pro-rata
1 share to the remaining six shares.
 In second situation with alternative of 1.6 pound per share share are required to be issued
are 112500 so here based on pro-rata 9 shares will be allocated against 48 right shares
issued. While in third situation with 1.4 pound each share no. of shares to be issued are
128571.43 thus based on prorata Issue 3 are offered against 14 right share to existing
shareholders.
(v) Evaluate the best option from three right issue:
Form analysis of above three alternatives it has been analysed that suggested value of
right share of 1.8 pound for each share would be much more advantageous comparatively
respective corporation since the projected earning per share (EPS) in such a case is greater than
other 2 alternative price options.
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(c) Evaluate the benefits of scrip divided in context of shareholders or companies
Scrip dividend: Scrip dividend defined as new stock for a corporation issued to
stockholders rather than a normal dividend. As company who issue have much little cash
accessible to issue cash dividend, a scrip dividends could be used, but they still need to charge
their stakeholders somehow. Shareholders might also be given scrip dividends as just an option
to monetary dividend in order to gradually carry out their dividend payouts into even more
shares. The downside for stakeholders is that if they acquire new securities, they don't have to
bear any transaction costs, like commission. It is also a substantial way of saving money by not
having to pay cash dividend payments for stock issuer. Scrip dividends linked to common shares
help the distributing entity to maintain and encourage shareholders to raise their investment in
the corporation. not only does this reduce costs of purchasing stock options, but it could also
offer a tax deduction for the shareholder. For instance, rather than earnings, the shareholder
realizes capital gain. The capital gain can be taxed at reduced percentage than regular dividends.
The company utilise this strategy when it has to pay-out their inventors, since they don't have
enough funds for it. This refers primarily to the freshly generated securities compared to existing
securities (Burtonshaw-Gunn, 2017). In many situations, it'll be viewed as a category of debt that
has certain advantages as well as pitfalls in both the company and the investors. Additional
assessment discussed below:
Benefits of Scrip dividend:
In context of company:
 This aid in maintaining corporation's cash-funds position as here in this kind of dividend
mostly shareholders go with the option of shares. Due to this company's cash funds as
well as equity increase.
 Due to issuance of shares under option of scrip dividend, company's leveraging and
gearing position may improve which leads to enhancement in overall borrowing capacity
of corporation.
 A corporation with higher brand value and good market position, can issue this type of
dividend even with limited cash funds if company ensure that most of the go with share
alternative.
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 Another advantageous thing here is that smaller scrip dividend issuance generally not
dilutes company's share price majorly. Although where company is not offering cash as
an alternate, experiential grounds proposes that shares' price will be fall. It also a significant source of finance and funding due to option of shares against
dividend.
In context of shareholders:
 Most prime advantage for shareholders, of a scrip dividend is that they can get tax
advantages by adopting the option/alternative of shares.
 Shareholder who have desire to make an increase in their shareholding in company this
dividend is beneficial as they can enhance shareholding without any additional
transaction costs.
 Share option in scrip dividend may provide a greater monetary benefits as compare to
cash dividend so mostly shareholders wants to get scrip dividend.
QUESTION 3
a. Investment appraisal technique
(I) Payback Period:
This is a capital budgeting technique that is meant to assess the new
investment's viability and to support the individual decision of selection of most appropriate
investment alternative. Payback period defined as specific duration over which the company will
reimburse the amount of money invested. Minimal payback duration is advantageous to the
organization as it allows to retrieve initial investment and commence to generate yields on it. It
allows managers to assess whether investment made on any option is capable to return back
within a reasonable period. Payback period is mandated to recuperate negative
project/venture cash from the purchase and/or initial years for positive project/venture cash flow.
Payback may be measured either from beginning of a proposal or from beginning of production
process. Payback periods are usually measured on the basis of undiscounted cash-flows, but it
may even be estimated at minimum return rate(%) for Discounted Cash Flows (Arnold, 2012).
The insight that investor wants to retrieve the spent capital at the earliest opportunity is driving
payback measures. Below is specific formula for computation of payback period, as follows:
Formula: Payback Period = Initial investment / cash inflow
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Calculation as accordance of investment appraisal techniques.
(I) Payback period
Initial investment 275000
Cash inflow 85000
Cash outflow 12500
Cash flow 72500
Payback period 3.79
(ii) Accounting rate of return:
ARR reported as percentage of projected investment returns company will get. This is
another of simplest or fastest way of investment evaluation that the company usually uses with
project selection. The total income is measured by dividing this from initial investment. ARR is
technique of capital budgeting that does not accurately reflect the time's value of money and
cashflows. The more the return appears advantageous to the corporation, meaning company
receives the better yields, while the weaker return isn't really beneficial. Organization measures
the results of several projects and choices are made directly by executives. The table in the below
shows the simple calculation method of ARR for period of 6 years in which the relevant return is
obtained (Cangiano, Curristine and Lazare, 2013). Thus, the corporation's executives have to
devise their tactics accordingly as well as decide to choose whether or not pick this venture
for investment. Following are the ARR computations, as follows:
Formula: Accounting rate of return = Average annual profit / Initial investment * 100
Cash inflow £85,000
Cash outflow £12,500
Net cash flow
(Cash inflow – Cash outflow) £75,500
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Step 1
Year £ Net cash flows
£ Residual
value £ Depreciation
Annual
profit
1 72,500 0 38,958.33 33,541.67
2 72,500 0 38,958.33 33,541.67
3 72,500 0 38,958.33 33,541.67
4 72,500 0 38,958.33 33,541.67
5 72,500 0 38,958.33 33,541.67
6(Cash flows + residual
value –year depreciation) 72,500 41,250 38,958.33 74,791.67
Step 2
Average profit = (year 1+…+year 6 profit) / numbers of years
£242,500.02 / 6 = £ 40,416.67
Step 3
Average capital = (initial cost + residual value) / 2 = (£275,000 + £41,250) / 2= £158,125
Step 4
ARR= Step2 / Step3 * 100% = £40,416.67 / £158,125 *100% = 25.56 % profitability
(iii) Net present value (NPV): NPV corresponds to a proposal's net present value, this is main
method that organisations commonly use to make decisions. It includes a profound cash inflow
evaluation that occurs at distinct periods of time. A project's NPV is computed by introducing all
cash in-flows as well as out-flows to PVs (present values). Cash inflows get a constructive
symbol whereas cash outflows get a negative symbol. Furthermore, the discounted rate element
of cash-flow is the most crucial aspect necessary for analysing and considering the net present
value in calculation. The NPV is a statistic that can decide if a financial move is an investing
opportunity or not. This is simply a present-value of all cash-flows (with net cash flows
including net outflows), that also means NPV could be called an income formula minus
expenditures (Jindrichovska, 2013). When NPV is positive-value, that implies revenue worth
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(cash in flows) is higher than costs (cash-outflows). The investor generates a return when the
profits are higher than the expenses. Here is computation of NPV, as follows:
Formula: NPV (Net Present Value) = Discounted cash inflow / Initial investment or outlayStep
Cost of capital 12% (R1)
Year £ Cash flows Cost of capital (12%)
(annuity table)
£ Present value (cash flow * cost
of capital @12% from annuity
table)
0 (275,000) 1 (275,000.00)
1 72,500 0.893 64,742.50
2 72,500 0.797 57,782.50
3 72,500 0.712 51,620.00
4 72,500 0.636 46,110.00
5 72,500 0.567 41,107.50
6 ( cash flow +
residual value) 113,750 0.507 57,671.25
NPV1 (year 1+...+year
6)-year0 44,033.75
(iv) IRR (Internal Rate of Return):
Internal Return Rate (IRR) is amongst the most relevant methods in investment
assessment and should be used by mostly organisations to determine their strategy to determine
that they're either efficient or not (Mien and Thao, 2015). Internal rate of return on basis of the
cumulative cycle determining the net present value and thus defining cash flow for the particular
project. Until making certain future investment plans, companies need to assess their investment
using capital budgeting process and take additional steps accordingly. Internal Rate of Return
(IRR) is a fiscal metric utilized to calculate the expected performance of cash flow and also to
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compare project's / investment's feasibility. Other accounting metrics like Net Present Value
(NPV) or Returns on investment (ROI) are commonly associated with IRR. It is described
as discount rate at which corporation can ensure that investment is pricier than its real cost
(Banerjee, 2015). That's the rate by which NPV is nil, in simple words. When value of IRR is
lower than cost of capital, then project should be turned down, otherwise project could be
adopted. Following are the calculation and formula of IRR, as follows:
Formula: Internal Rate of Return (IRR) = LDR + PV of LDR – Initial investment / PV of HDR
– PV of LDR (HDR – LDR)
Increase cost of capital at 20% (R2)
Year £ Cash flows
Cost of capital (20%)
(annuity table)
£ Present value (cash
flow * cost of capital
@20% from annuity
table)
0 (275,000) 1 (275,000)
1 72,500 0.833 60,392.50
2 72,500 0.694 50,315.00
3 72,500 0.579 41,977.50
4 72,500 0.482 34,945.00
5 72,500 0.402 29,145.00
6 113,750 0.335 38,106.25
NPV2 -20,118.75
R1 = 12
R2 = 20
NPV1 = £44,033.75
NPV2 = -£ 20,118.75
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Recommendation:
It has been inferred from above conclusion that for Lovewell corporation it would be both
advantageous and productive if they bought new machines for business processes. since it being
evaluated that payback period of whole project is around 3.79 years in case Lovewell invests in
new machinery. That means that in about 4 years, the corporation recovered the balance as well
as accounting return rate is around 25.56 percent. It's also noted that ARR (%) is at favourable
condition, it means that when they spend funds in this venture, they will have return of approx.
12 percent, that is both quite good and financially viable for business. Here, machine's net
present value assessed is 44,033.75 GBP which is favourable, indicating that expenditure in
purchase this machinery is advantageous to the corporation Lovewell. This proposal's IRR is
around 17.52 percent, which is also sufficient reason to spend money on new machinery and
increase business outputs and profitability. Using the findings described above, management can
make decisions in support of this venture, which is advantageous for the company to spend in
new machinery for improved performance.
b. Critical evaluation of investment appraisal techniques with the help of its benefits &
drawbacks
Payback period:
Benefits:
 The payback method's very effective attribute is its elegance or simpleness. Comparing
several ventures and afterwards selecting the one with the shorter payback period is an
easiest approach.
Drawbacks:
 Only because a proposal does have a small period of payback doesn't imply this is
profitable When cash flows cease at payback period or who are drastically cut, a venture
may never yield a benefit and it may thus be an imprudent investment.
Anything that occurs following the recovery of capital costs won't impact project's payback
period, as well as the reimbursement period, is really a drawback (Parker, 2012).
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Accounting rate of return:
Benefits:
 It demonstrates an investment-proposal's profitability and enables quantify the project's
existing performance.
 This technique makes it possible to compare different ventures of a competitive essence.
 That is fast and easy technique that utilizes an investment-proposal's profit to asses the
return rapidly.
Drawbacks:
 This approach disregards external variables, and when the same proposal is evaluated
using this technique, the outcomes will also be different.
When comparing different investment-proposals, this model doesn't really contemplate the life
cycle of different investment-proposals and, as needed, it might not generate the exact outcomes
(Pham, Yap and Dowling, 2012). Another one method's major drawbacks is that it disregards totally time factor.
Money's time value is also a valuable determinant in determining the investment
feasibility.
Net Present value (NPV):
Benefits:
 One benefit of this method is its concern of money's present time value. During intervals
of inflationary pressures, value of money keeps changing over time. As in future, a
corporation could not rely on cash worth same amount as it is currently.
 Another benefit of net present value technique is its tendency to compare investments.
Because each proposal is evaluated by the organization, it computes the project's existing
complete value. The estimate takes into account at time of the exchange each
of anticipated cash returns and cash pay-outs and value of money.
Drawbacks:
 The downside of this approach is the application of assumptions. organization has to
make decisions about both amount and the pace of potential project-related cash
transactions. Organization also has to predict it's interest-rate for project period.
Internal Rate of Return (IRR):
Benefits:
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 The main and very critical aspect is that while assessing a venture, the internal rate of
return takes into consideration time value of money.
 The most appealing thing regarding this technique is that forward to calculating the
IRR, it's very easy to perceive. When the IRR outweighs capital cost, the proposal will be
accepted, and not otherwise.
Drawbacks:
When evaluating a project using IRR approach, it essentially implies that the positive future
cash-flows at IRR will be reinvested for the proposal's remaining duration (Dudin, Lyasnikov,
Yahyaev and Kuznecov, 2014).
CONCLUSION
The study above concluded that for organization, financial management is quite crucial to
preserve its financial position. This is the mechanism that reflects on the organization and every
part or operation. Management develops plans by market and organizational success
concentration. Further, the organization should offer a scrip kind dividend which optimize the
numbers of shareholders and the valuation of assets in order to preserve profitability and stability
within the enterprise. In addition, enterprise uses an investment evaluation method to measure
the numerous aspects of the analysis in order to support effective decision about investment. For
instance, payback duration, return accounting rate, IRR percent, NPV, and so on. These all are
capital budgeting approaches that help management focus on potential investments for the
enterprise's growth.
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REFERENCES
Books and Journals
Shapiro, A.C. and Hanouna, P., 2019. Multinational financial management. Wiley.
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Learning.
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.
Burtonshaw-Gunn, S.A., 2017. Risk and financial management in construction. Routledge.
Arnold, G., 2012. Corporate financial management. Pearson Education.
Cangiano, M.M., Curristine, M.T.R. and Lazare, M.M., 2013. Public financial management and
its emerging architecture. International Monetary Fund.
Jindrichovska, I., 2013. Financial management in SMEs. European Research Studies
Journal. 16(4). pp. 79-96.
Banerjee, B., 2015. Fundamentals of financial management. PHI Learning Pvt. Ltd..
Parker, L.D., 2012. From privatised to hybrid corporatised higher education: A global financial
management discourse. Financial Accountability & Management, 28(3), pp.247-268.
Pham, T.H., Yap, K. and Dowling, N.A., 2012. The impact of financial management practices
and financial attitudes on the relationship between materialism and compulsive
buying. Journal of Economic Psychology, 33(3), pp.461-470.
Dudin, M., Lyasnikov, N., Yahyaev, M. and Kuznecov, A., 2014. The organization approaches
peculiarities of an industrial enterprises financial management. Life Science
Journal, 11(9), pp.333-336.
Mien, N.T.N. and Thao, T.P., 2015. Factors affecting personal financial management behaviors:
evidence from vietnam. In Proceedings of the Second Asia-Pacific Conference on
Global Business, Economics, Finance and Social Sciences (AP15Vietnam Conference),
10-12/07/2015.
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