Business Finance: Capital Investment Appraisal, Source of Finance

This document provides an overview of capital investment appraisal and different sources of finance in business finance. It explains the advantages and disadvantages of each method, such as payback period, net present value, accounting rate of return, and internal rate of return. The document also includes a task on choosing the best country for investment based on financial analysis. Suitable for students studying business finance or related courses.

BUSINESS FINANCE

Contents
INTRODUCTION.......................................................................................................................................3
MAIN BODY..............................................................................................................................................3
1. Capital investment appraisal:...........................................................................................................3
2. Source of finance:..........................................................................................................................14
3. Flexible budget:.............................................................................................................................17
4. Break Even Analysis......................................................................................................................20
CONCLUSION.........................................................................................................................................22
REFERENCES..........................................................................................................................................24

INTRODUCTION
Corporate finance requires the assets and investments invested in the business. The
foundation of a company is finance. Acquisition of land, commodities, raw materials and the
other business activity flows are financial requirements (Ylhäinen, 2017). This is essential to
business entities to manage their financial resources in an effective manner so that total
utilization can become possible. The project report is based on an international company that
produces fashion cloths for different retailers of UK and USA. The project report consists
information about various tasks. Such as initial part of report is based on capital investment
appraisal under which different calculations are done as per methods. In the second task of report
different financial terms explained like bank overdraft, factoring, lease and many more. The third
part of report consists information about flexible budget and variance. While the end part of
report covers information about breakeven point and its calculations.
MAIN BODY
1. Capital investment appraisal:
Task 1 calculation:
 Payback period
Country- Ethiopia
Investment= 500000
Year Cash flow
1 160000
2 160000
3 160000
4 160000
5 160000

Payback period= Initial investment/cash flow
= 500000/160000
= 3.125 Years
Country- Morocco
Investment= 500000
Year Cash flow Cumulative
cash flow
1 190000 190000
2 180000 370000
3 170000 540000
4 160000 700000
5 150000 850000
Payback period= Year before recovery + amount to be recover/next year cash
flow
= 2+130000/170000
=2.76 years
Country- Bulgaria
Investment= 500000
Year Cash flow Cumulative
cash flow
1 50000 50000
2 100000 150000
3 150000 300000
4 250000 550000

5 350000 900000
Payback period= 3+200000/250000
= 3.08 years
 Accounting rate of return:
Country- Ethiopia
Investment= 500000
Year Cash flow
1 160000
2 160000
3 160000
4 160000
5 160000
ARR= Average annual profit / investment*100
= 160000/500000*100
= 32%
Country- Morocco
Investment= 500000
Year Cash flow
1 190000
2 180000
3 170000
4 160000

5 150000
Total profit= 850000
Average profit= 850000/5
= 170000
ARR= 170000/500000*100
= 34%
Country- Bulgaria
Investment= 500000
Year Cash flow
1 50000
2 100000
3 150000
4 250000
5 350000
Total profit= 900000
Average profit= 900000/5
= 180000
ARR= 180000/500000*100
= 36%

 Net present value:
Cost of capital= 15%
Country- Ethiopia
Investment= 500000
Yea
r
Cash
flow PV
factor
Discounte
d cash
flow
1 16000
0 0.8696 139136
2 16000
0 0.7561 120976
3 16000
0 0.6575 105200
4 16000
0 0.5718 91488
5 16000
0 0.4972 79552
536352
NPV= Discounted cash flow-initial investment
= 536352-500000
= 36352
Country- Morocco
Investment= 500000
Year Cash
flow PV
factor
Discounte
d cash
flow
1 19000
0 0.8696 165224
2 18000
0 0.7561 136098

3 17000
0 0.6575 111775
4 16000
0 0.5718 91488
5 15000
0 0.4972 74580
579165
NPV= 579165-500000
= 79165
Country- Bulgaria
Investment= 500000
Year Cash
flow PV
factor
Discounte
d cash
flow
1 50000 0.8696 43480
2 10000
0 0.7561 75610
3 15000
0 0.6575 98625
4 25000
0 0.5718 142950
5 35000
0 0.4972 174020
534685
NPV= 534685-500000
= 34685
 Internal rate of return

IRR = Lower Discounted Rate + PV of Lower Discounted Rate – Initial
investment / PV of High Discounted Rate*(HDR – LDR)
Country- Ethiopia
Investment= 500000
Lower discount rate- 15%
Yea
r
Cash
flow PV
factor
Discounte
d cash
flow
1 16000
0 0.8696 139136
2 16000
0 0.7561 120976
3 16000
0 0.6575 105200
4 16000
0 0.5718 91488
5 16000
0 0.4972 79552
536352
Higher discounting rate- 20%
Yea
r
Cash
flow PV
factor
Discounte
d cash
flow
1 16000
0 0.8333 133328
2 16000
0 0.6944 111104
3 16000
0 0.5787 92592
4 16000
0 0.4823 77168
5 16000 0.4019 64304

0
478496
IRR= 15+536352-500000/478496*(20-15)
= 15+36352/478496*5
= 15+0.38
= 15.38
Country- Morocco
Investment= 500000
PV at 15%
Year Cash
flow PV
factor
Discounte
d cash
flow
1 19000
0 0.8696 165224
2 18000
0 0.7561 136098
3 17000
0 0.6575 111775
4 16000
0 0.5718 91488
5 15000
0 0.4972 74580
579165
PV at 20%

Year Cash
flow PV
factor
Discounte
d cash
flow
1 19000
0 0.8333 158327
2 18000
0 0.6944 124992
3 17000
0 0.5787 98379
4 16000
0 0.4823 77168
5 15000
0 0.4019 60285
519151
IRR= 15+579165-500000/519151*5
= 15+79165/500000*5
= 15.79%
Country- Bulgaria
Investment= 500000
PV at 15%
Year Cash
flow PV
factor
Discounte
d cash
flow
1 50000 0.8696 43480
2 10000
0 0.7561 75610
3 15000
0 0.6575 98625

4 25000
0 0.5718 142950
5 35000
0 0.4972 174020
534685
PV at 20%
Year Cash
flow PV
factor
Discounte
d cash
flow
1 50000 0.8333 41665
2 10000
0 0.6944 69440
3 15000
0 0.5787 86805
4 25000
0 0.4823 120575
5 35000
0 0.4019 140665
459150
IRR= 15+534685-500000/459150*5
= 15+34685/459150*5
= 15.34%
Task 2 – Briefly explain the advantages and disadvantages of each method.
Payback period- It determines additional expenditures and allows the user to accept or
choose the right alternative. It is the approach of capital budgeting (Bendell and Doyle, 2017).
The payback term applies to the duration of the customer's checks. The business gains from a

quick payback time, which allows initial investments to be recuperated and income to be
maximized.
Advantage- The advantages of the payback period method are that it is especially beneficial for a
small company who does not have to carry out complex calculations, including selling expenses
and the revenue effect. Whether or not a project is selected is one of the most significant
strategies for the project calculating which is good for the consumer. This approach helps
managers to pick the right allocation of investments. This will entail a fast changeover, because
that would allow the business to bounce back from the initial investment sooner.
Disadvantage- The most important downside of the payback scheme is the absence of accounting
of interest on the duration. Cash flow is more critical than in later years in the first years of a
project. Two firms are bound by the same payback date. Yet one expenditure produces more
cash flow during the first few years
Net present value- NPV relates to the overall assessment actually being made of the plan,
one of the key tools employed by organizations for decision taking. This calls for a close analysis
of various intervals of cash inflow.
Advantages- The majority of companies use the NPV to determine commitment and assess
whether the company participates in this program. The positive value of the identified NPV and
its negative is rejected, because that is not a aid to the client (Adhikary and Kutsuna, 2016).
Disadvantages- Administrators may use this method for evaluating the feasibility of their firms
or to equate them to other deals, but just that the investment matches all cash flows.
Accounting rate of return- ARR assess in absolute terms the estimated cost of investment
gain or selling of the product. It is a strategic expenditure assessment and is one of the simplest
or quicker utilized by the client for project collection.

Advantage- ARR supports businesses in spending. Sustainable and profitable earnings are strong
for the company. The management tests the ARR concept by choosing the correct layout before
settling on it.
Disadvantage- The value of resources in terms of time is not taken into account. The
methodology to capital expenditure assessment is also unscientific. For average returns, all
estimating losses and gross income do not compensate for cash flow of investments (Burns and
Dewhurst, 2016).
Internal rate of return- IRR is one of the main investment appraisal tools for most businesses
to determine if their recommendations are effective or not. Individual returns focused on a
shorter duration, calculating the real profit and evaluating the cash flow for the project involved.
Advantage- IRR is used only to define rates of return the team earns following the expenses and
then to take appropriate additional decisions.
Disadvantage- IRR recognizes economies of scale that adversely impact results. It is determined
by a control and impact process that does not yield accurate performance. The strategic decision-
making systems are also influenced.
Task 3 – Which country should the company invest in?
Payback period- On the basis of above calculated value of payback period, this can be
stated that company should go with Morocco country. This is so because under it, cost of
investment will be covered in less time in this country.
Accounting rate of return- On the basis of above calculated value of ARR, this can be
stated that company should go with Bulgaria country. This is so because under it, value of ARR
is higher that is of 36% and it is more than rest two countries.
Net present value- On the basis of above calculated value of NPV; this can be stated that
company should go with Morocco country. This is so because under it, value of NPV is higher
that is of 79165 and it is more than rest two countries.

Internal rate of return- On the basis of above calculated value of IRR; this can be stated
that company should go with Morocco country. This is so because under it, value of IRR is
higher that is of 15.79 and it is more than rest two countries.
So, as per the above analysis this can be stated that company should go with Morocco because in
this country, company will sustain for long time period and will be able to generate higher
profit.
2. Source of finance:
Task 1 Difference between Ordinary Shares, Preference Share, Retained Profit and
Debentures.
Basis Ordinary Shares Preference Share Retained Profit Debentures
Meaning A common stock
is a part owner
where each
participant is a
partial owner and
sets out the
maximum
corporate liability
linked to a manage
earnings.
Preferred shares is
a form of shares
that may have a
mixture of
common equity
and debt
instrument
characteristics
which does not
include properties,
and is usually
considered a
hybrid component.
The corporation's
retained profits
are the
cumulative net
profit of the
business that is
maintained by
the corporation
for a certain date,
for example
towards the close
of the tax cycle.
A debenture is a
sort of collateral-
unsecured lending
tool. Since there is
no liquidity
protection for
debentures, the
debentures will be
backed by the
creditworthiness
and prestige of the
borrower. Both
corporations and
organizations often
issue debentures in

order to raise funds
or capital.
Voting
rights
Such types of
stockholders have
the right to vote in
any institution
(Klopotan, Zoroja
and Meško, 2018).
These shareholders
do not have any
voting rights.
There are not
external
stakeholders of
this profit as it is
generated inside
the firm.
The debenture
holders also do not
have voting rights.
Return Equity share
holders are being
paid dividend after
preference
shareholders.
They get a fixed
amount of
dividend before
ordinary share
holders.
It is a sort of
profit in which
no return is
provided to
anyone.
The debenture
holders also get a
common dividend.
From above all source of finance, company can raise funds of 500000 pounds from ordinary
shares. This is so because it is less risky and company does not require paying any fixed
amount of dividend to these shareholders.
Task 2 Differences between Leasing, Hire Purchasing and Bank Loan:
Basis Leasing Hire Purchasing Bank Loan
Meaning Leasing is a contract
where one party buys
the goods and permits
the other party to use
them by paying for a
certain period is known
as leasing. Leasing is an
agreement.
Hire Purchasing is called
the contract in which one
group can use the other
group's assets for
equivalent monthly
installments.
In financial words, a
loan is the lending to
certain persons,
organizations or other
institutions with
capital. The borrower is
obligated to pay
interest on the loan, and
generally to repay the
principal sum lent
before the loan is

refunded.
Down
payment
Under it down payment
is not required.
In this, down payment is
needed.
There is no need of
down payment.
Installments Cost of using assets. Principle plus interest. Principle plus interest.
Ownership Property transfer
depends on the lease
form.
On the payment of the
last share, possession of
the commodity is passed
to the employ buyer
(Mian and Sufi, 2018).
Under it, bank take
assets of customer and
loan is provided on the
behalf of value of those
assets.
As per the given case, company wants to buy machine whose cost is of 100000 pounds. They
have three options which are leasing, hire purchasing and bank loan. Among these three
methods, company should go with bank loan. This is so because under it they can buy
machine and they will be owner of that machine. As well as they will have option to resell
this machinery in future. While in other methods, they can get machine just for rent not for
long time period.
Task 3 – Briefly explain Bank overdraft, Factoring, Trade Creditors.
 Bank overdraft- A credit overdraft is a loan extension given by a loan company
when an account reaches zero. The overdraft enables the manager of the loan to
start borrowing money even though the loan does not have enough funds or
inadequate funds to meet the withdrawal volume. In theory, an overdraft would
require the Bank to borrow a certain amount. The debt is interest so there is
typically an excess tax (Haldane, 2016).
This source of fund can be used in the case when a customer does not have
enough amount of fund in the account. As well as it is a short term source of
finance.
 Factoring- Factoring is a banking operation and a kind of debtor financing where
a firm offers its receivable accounts at a loss to a third parties. Often a company
can use its receivable funds to meet its current and imminent cash requirements.

It is being used by companies when they need cash urgently as under this method
companies can sell their receivables to others.
 Trade Creditors- Suppliers of which the supplier is obligated to pay for raw
materials or parts of a good. Deal partners and the sums to be due are classified as
obligations in corporate accounting procedures.
The source of finance is provided by suppliers to companies for short time period
when company does not have enough amounts of financial resources.
3. Flexible budget:
Task 1 Preparation of flexible budget-
Flexed budget operating statement for the year 31ST January 2019:
Particulars Budget Flex Actual Variance
Level of activity 50% 60% 60%
£ £
Costs:
Direct material 50000 60000 61000 1000 F
Direct labor 100000 120000 118000 2000 A
Variable overheads 10000 12000 14000 2000 F
Total variable cost 160000 192000 193000 1000 F

Fixed overheads 40000 48000 42000 6000 A
Comment on findings- On the basis of above prepared flexible budget, this can be stated that all
the variances are showing adverse result. This is so because each aspect or expense is higher than
budgeted expense. Due to which result is negative. In this situation, it is essential for companies
to focus on minimizing their expenses and try to keep the value of cost lower then estimation.
Task 2 Behavioral issues in budgeting and its importance in budget setting.
There are behavior issues in budgets, such as manager's ineffective actions and budgetary
slackness. Such behavioral issues are made more apparent when analyzing their current results
and evaluating budget performance. Below some issues in budgeting are mentioned that are as
follows:
 Dysfunctional Behavior- Budgets can bring positive behavior among people if
each manager’s objectives conform to the organization's goals (Heaton, Polson
and Witte, 2017). The perfect match (or close correspondence) between
organizational and management objectives is often referred to as the goal
congruence. Managers participating with the planning cycle should be happy to
deliver a realistic proposal for their organizational priorities and objectives.
 Participative budgeting- Participatory budgeting is a budgeting mechanism that
includes citizens in the lower management ranks in the process of planning the
budget. In comparison to the budgeting mechanism implemented, participatory
budgeting is important for offering lower management a sense of control in the
company.
 Budgetary slack- Budgetary slowness is often known as budget padding where a
planner intentionally underestimates revenue, overestimates expenses and needs
more capital than is necessary to sustain the budget amount of operations. The
discrepancy between a person's sales or expense projections versus a reasonable
expenditure or benefit projection is defined as fiscal slackness.

 Inter-Departmental Conflict- The process of budgeting is rightly regarded as
technical and official. In fact, though, budgeting is more frequently an informal
mechanism for discussions or where departmental managers fight for limited
resources in the company. According to Hopwood, this can dilute the initial aims,
as managers’ attempt (and struggle) to gain control and respect. Departmental
disputes or disagreements between the administrators are often related to the fact
that each organization struggles to reach its goals.
So these are the main behavioral issues in budgeting and these are important for budgeting
due to following reasons:
Budget is a critical tool for controlling. It can help to plan, implement, implement and
manage the company's strategic plan. There are behavior issues in budgets, such as manager's
ineffective actions and budgetary slackness (Cumming and Vismara, 2017). These behavioral
problems become more apparent in comparison and assessment of budget performance with
their actual performance. The outcome of the analysis and assessment may be directly linked
to the reward level. On the basis of it, manager of companies take suitable steps for next year
financial plan.
4. Break Even Analysis
Task 1 calculation:
 C/S ratio= Contribution / sales *100
= 3/7*100
= 42.86%
Working Note:
Contribution= sales-variable expenses
= 7-4

= 3 Pounds
 Breakeven point (In units)= Fixed cost/contribution
= 50000/3
= 16666 units
 Breakeven point (in sales)= Fixed cost/ PV ratio
= 50000/42.86%
= 116658 pounds
 Number of units to make profit of 31000 pounds:
Units to be sold= Desired profit / Contribution per unit + Breakeven point in units
= 31000/3+16666
= 27000 units
 Sales value to make profit of 31000 pounds:
Sales value to make profit= Desired profit / Contribution per unit + Breakeven
point in sales
= 31000/3+116658
= 126991 pounds
Task 2 Break even chart:

Task 3 briefly explains the advantages and disadvantage of using Breakeven Analysis for
managers.
Break even point- The break-even point type is determined in accounting by calculating
the gross fixed cost of output by profit per item, minus variable costs per element (Visser, 2019).
Fixed expenses are in this case ones that don't differ due to the amount of units produced. Under
other terms, the amount of output at which net income is equivalent to total expense for the
commodity is the breakeven stage. It has below mentioned advantages and disadvantages:
Advantages:
 The C-V-P analysis helps to choose between the two actions to be taken and not
to be purchased. If the variable expense is smaller than the price charged to a
third-party supplier, producing could be better than buying (Gomber, Koch and
Siering, 2017).
 It plays an important function in modifying the company paradigm of
management strategies. The company wants, for example, to move from a
manufacturing plant to a development center. Before taking these decisions, it

will consider explicitly and perceive the potential expenses, production and
projected revenue and benefit.
Disadvantages:
 The break-even diagram is based on assumptions. But the assumptions are not
right. In addition to the actual operating point, the fixed costs will differ.
Similarly, if the rule of the decrease or increase in return is valid in the company,
variable costs shall not differ in direct relation to degree of service.
 The total cost line and the sales line appear straight in the break-even chart.
Because these definitions are not right, in reality these lines are not drawn
straight. It contributes to different break-even points at varying operation stages
(Cochrane, 2017).
CONCLUSION
On the basis of above project report this can be concluded that company should make
proper analysis of available funds. From the first part of report this can be concluded that
company should start their business in Morocco country because all methods are showing that
investing in this country will be beneficial for them. Under second part various kinds of source
of finance are mentioned and each of them has some features and drawbacks. The further part of
report concludes about flexible budget and variances as well as role of budgetary slack in budget
setting. The end part of report articulates about calculation of BEP and its advantages &
drawbacks.

REFERENCES
Books and journal:
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Finance, 77, pp.176-196.
Bendell, J. and Doyle, I., 2017. Healing capitalism: five years in the life of business, finance and
corporate responsibility. Routledge.
Adhikary, B. and Kutsuna, K., 2016. Small Business Finance in Bangladesh:
Can'Crowdfunding'Be an Alternative?. Review of Integrative Business and Economics
Research, 4, pp.1-21.
Burns, P. and Dewhurst, J. eds., 2016. Small business and entrepreneurship. Macmillan
International Higher Education.
Klopotan, I., Zoroja, J. and Meško, M., 2018. Early warning system in business, finance, and
economics: Bibliometric and topic analysis. International Journal of Engineering
Business Management, 10, p.1847979018797013.
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channel. Journal of Economic Perspectives, 32(3), pp.31-58.
Haldane, A., 2016. Finance Version 2.0. Speech, Bank of England, 7.
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portfolios. Applied Stochastic Models in Business and Industry, 33(1), pp.3-12.
Cumming, D.J. and Vismara, S., 2017. De-segmenting research in entrepreneurial
finance. Venture Capital, 19(1-2), pp.17-27.
Visser, H., 2019. Islamic finance: Principles and practice. Edward Elgar Publishing.
Gomber, P., Koch, J.A. and Siering, M., 2017. Digital Finance and FinTech: current research and
future research directions. Journal of Business Economics, 87(5), pp.537-580.
Cochrane, J.H., 2017. Macro-finance. Review of Finance, 21(3), pp.945-985.