Finance Management: Long term finance and Investment Appraisal techniques

This document provides an overview of finance management, focusing on long term finance and investment appraisal techniques. It discusses the benefits of scrip dividend for shareholders and companies. The document also includes calculations using the payback period, accounting rate of return, net present value, and internal rate of return methods.

Finance Management

Table of Contents
INTRODUCTION...........................................................................................................................1
QUESTION 1...................................................................................................................................1
(a) Long term finance: Equity finance........................................................................................1
QUESTION 3...................................................................................................................................5
(a) Calculations using the following Investment Appraisal techniques......................................5
(b) Benefits and limitations of each of differing investment appraisal techniques ....................9
CONCLUSION .............................................................................................................................11
REFERENCES..............................................................................................................................13

INTRODUCTION
Financial management is defined as a procedure of effective preparation, arranging and
dominating of monetary resources. The term mainly consist of financial aspects and decisions in
regard of size of investments, sources and range of utilisation for capital to generate more
profitability in the business. For the maximization of profitability in the business requires to
focus on the financial resources that manage by management techniques (Al Ahbabi and
Nobanee, 2019). In the business finance manager apply different financial principal for the
financial assets and manage all the resources. The main aim of the report to understand the term
of financial management in context of business entity. This report based on the financial
management where different organisational are applying different types of financial techniques
to manage all the financial activities in effective manner. In this report consist of two questions,
first one is Long term finance: equity finance and second one is investment appraisal techniques.
QUESTION 1
(a) Long term finance: Equity finance
Issue of right share: It is a method for listed organisations to raise their capital. Right
issue is invitation for the presently shareholders to but new shares of organisation and it is gives
extra securities to exiting shareholders. Any organisation can issue right share whether public,
private and listed or unlisted company. These shares are offering to new customers when
existing customers are not ready to accept in the set time period of 15 days or more. In the
contest of Lexbel Plc want to issue right issue share to existing shareholders of completing
financial requirements (Antonopoulos and Hall, 2016). There are given the information of Issue
of right shares such as:
Lexbel plc wishes to rise: 180000 Pounds
Current ex-dividend market-price of Lexbel plc: 1.90 Pounds
3 assorted rights-issue prices recommended by corporation's finance director: GBP1.80, GBP
1.60 and GBP1.40
Right issue of Lexbel plc (In 000) (In 000)
…....Aggregate (no.)Ordinary shares (@ 50
for each) …....300 Pounds
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…....Add: Aggregate Reserve …....400 Pounds
…....Whole Sum …....700 Pounds
…....Profit Post taxation ( 700 pounds x 20
percent) …....140 Pounds
(I) Number of shares to be issued = (…....Aggregate Funds to be elevated / right issue
prices…....)
Descriptions
Amount (in
pound except
shares 000)
Amount (in
pound except
shares 000)
Amount (in pound
except shares 000)
…....Exist number of share …....600 …....600 …....600
…....Fund to be raised (A) …....180 …....180 …....180
…....Suggested right issue prices (B) …....1.8 …....1.6 …....1.4
…....Number of shares to be issued: 1/2 …....100000 …....112500 …....128571.43
Theoretical Ex price:
It is estimated price of shares of an organisation following a right issue. When company
issue right issue that time offer to existing shareholders in discounted price. Stock prices are
impacted by new rights issuances due to enhance the number of outstanding shares. A theoretical
ex rights price is beneficial for stock issued by a rights offering (Ashmarina, Zotova and
Smolina, 2016). TERP is lesser than the market value of a share prior to the right issues due to
shares under rights issues transactions are normally issued at lesser price the prevailing market
price. The main aim of this price offering to enhance the capital of the business with the priority
of existing shareholders.
2

Particular Condition one Condition two Condition third
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
…....128571.43s
hares
Pre right issue …....1140000 …....1140000 …....1140000
Post right issue …....1320000 …....1320000 …....1320000
Theoretical ex-right price 1.89 1.85 1.81
Expected earning per share: There are different financial experts who is used earning
per share to analysis the income of business on each share. Expected EPS define about the
investors how much money per share outstanding a business is expected to make
(Bulturbayevich and et.al., 2020).
Anticipated earnings per share (EPS) = For the measurement apply the above formula:
Share before issue of rights x TERP/ Recent market price.
In the context of above given scenario, it can be find out that:
Recent market rate = 1.9
Number of shares available = 600000 shares
Return on shareholders’ fund = 140000 pounds
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(iv) Form of issue of right issue price:
Particular Amount (in pounds)
Amount (in
pounds)
Amount (in
pounds)
Suggested right issue prices …....1.8 …....1.6 …....1.4
Fund to be raise …....180000 …....180000 …....180000
Number of shares to be issued: …....100000 …....112500
…....128571.4
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Exist number of share …....600000 …....600000 …....600000
Ratio of new share to existing one …....0.17 …....0.19 …....0.21
Issue of right share hold by present
shareholder
Issue of 1 for 6 right
share hold
Issue of 9 for
48 right share
hold
Issue of 3 for
14 right share
hold
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As per the above calculation is has been determined that for the issue of shares, company
have three options that are following:
 As per the first situation, the first option is 1.80 Pounds for each share and required to
issue 100,000 shares of each share. Thus, shareholders must classified pro-rata one share
that available 6 shares (Georgieva, 2018).
 The option provide 1.60 Pounds per share are required to be issued of 112500 shares of
each share. Therefore, every stakeholders must provide their pro rata 9 shares that
available for 48 shares.
 In the third option provide 1.40 Pounds for every share are estimated to be issued on the
128571.43 shares of every share. Thus, stakeholders must classified pro-rata 3 shares for
available 14 shares.
Critically evaluate the best option among the three right issues
There are providing three options for issue of right share and as per the analysis it is
advised that value of right share of 1.8 Pound of each share will be profitable for Lexbel
company. Therefore, value of expected earnings per share is greater in this alternatives as
compare to rest of two options.
(b) Benefits of scrip dividend in context of shareholders and companies
Scrip dividend: It is described as a new shares of an issuer's stock that are issued to
shareholders rather than of a dividend. It is mainly utilised by the company when they has less
cash for the issue of cash dividend but still want to pay their stakeholders in specified way. Scrip
dividend many be provide as an option to a cash dividend so dividend payments are
automatically rolled into more shares (Goryakin and et.al., 2017). It is a way where organisation
allows to its stakeholders to take their dividends in form of share instead of cash. Thus from the
overall analysis it is saying that script dividend is beneficial for those organisations who is not
able to pay cash dividends so they are giving option to shareholders to take shares. There are
mentioned the benefits of the scrip dividend for companies as well as for stakeholders such as:
For shareholders
 The main advantage to shareholders of scrip dividend that painlessly enhance
shareholding in the business without having to pay broker's commission and stamp duty
on the rate of purchase share.
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 It is beneficial for those stakeholders who wants to increase their shares in particular
organisation so it will help to decrease transactions cost in effective way.
 It is another advantage that scrip dividend provide financial gain to shareholders due to
time travel of cash dividend.
 Moreover, scrip dividend for investors provide equity shares in same company without
paying extra amount like purchasing fees, commission, mediator fees and many others.
For company
 It is advantageous for organisation in case of have less cash liquidity so it will help to
provide option to investors to take issue of shares rather than of issuing cash dividends.
 Moreover, issuing of scrip dividend increase the leverage and gearing circumstances
organisational entities. Thus, issuing of shares as a dividend as compare to cash help
them in increase effective leverage condition (Masharsky and et.al., 2018).
 A business who have good brand position and goodwill can issue of shares easily when
company have not enough amount to pay dividend to its shareholders.
QUESTION 3
(a) Calculations using the following Investment Appraisal techniques
(a) Calculations-
(I) Payback period method- Initial investment / cash flow (when there is equal cash flow)
Initial investment = 320,000 pounds
Cash flow = Expected annual cash inflow – cash outflow
= 105000 – 15500
= 89500 pounds
Hence, cash flow = 320000 / 89500
= 3.57 years
So cost of this project will be recovered within 3 years and few months.
(ii) Accounting rate of return- Cash flow after depreciation / Initial investment x 100
Initial investment = 320000 pounds
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Particular Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Cash In-flow 105000 96050 87995 80745.5 74220.95
68348.8
6
(-) Cash out-flow 15500 15500 15500 15500 15500 15500
Net Cash flow 89500 80550 72495 65245.5 58720.95
52848.8
6
(-) Depreciation (on the basis of
reducing method @ 10%) 8950 8055 7249.5 6524.55 5872.1 5284.88
Net Cash flows after depreciation 80550 72495 65245.5
58720.9
5 52848.86
47563.9
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Initial investment 320000
Accounting rate of return 25.17%
Working notes:
Calculation of depreciation:
cost of machine (A) 320000
Net cash inflow (B) 15500
Life of machine (C) 6 years
Depreciation [(A-B)/C]
Net present value method:
Years
7

NPV= Discounted cash flow –
initial investment
Initial investment= 320000
Net Cash flow PV factor @ 12% DCF
Year 1 89500 0.892 79834
Year 2 89500 0.797 71331.5
Year 3 89500 0.711 6363.4
Year 4 89500 0.635 56832.5
Year 5 89500 0.567 50746.5
Year 6 89500 0.506 45287
Scarp Value 48000 0.506 24288
DCF 335382.9
Net Present value (NPV) = 335382.9 - 320000
= 15382.9
Internal rate of return:
Internal Rate of Return (IRR) = LDR + PV of LDR – Initial investment / PV of HDR – PV of
LDR (HDR – LDR)
= 12 + (335382.9 – 320000) / (313667.5 – 335382.9) * (20 – 12)
= 12 + 15382.9 / -21715.4 * (8)
= 12 + ( -0.71) * 8
= 12 – 5.68
= 6.32 %
Working notes:
PV at 12%
Years Net Cash flow PV factor @ 12% DCF
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Year 1 89500 0.892 79834
Year 2 89500 0.797 71331.5
Year 3 89500 0.711 6363.4
Year 4 89500 0.635 56832.5
Year 5 89500 0.567 50746.5
Year 6 89500 0.506 45287
Scarp Value 48000 0.506 24288
DCF 335382.9
PV at 20%
Years Net Cash flow PV factor @ 20% DCF
Year 1 89500 0.833 74553.5
Year 2 89500 0.694 62113
Year 3 89500 0.579 51820.5
Year 4 89500 0.482 43139
Year 5 89500 0.402 35979
Year 6 89500 0.335 29982.5
Scarp Value 48000 0.335 16080
DCF 313667.5
Recommendation:
 Pay back period: From the above calculation on Pay back period it is suggested that
Happy meal limited should go with the purchasing new machinery. After the calculation
it is getting that in 3.57 year company recover the cost from the machinery.
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 Accounting rate of return: As per the calculation the outcomes of ARR is 25.17% that is
greater and enough to recover cost of investment. Therefore, the Happy Meal limited
must purchase new machinery.
 Net present value: As per the method when an organisation get results in position that
time must go with project otherwise not. In context of Happy Meal limited, new
machinery value as per net present value is 1582.9 Pounds. Thus, it is suggested that must
acquire the new machinery.
 Internal rate of return: When company have higher internal rate of return so that time go
with the acquisition of new machinery. As per the calculation it is recommended that
company has 6.32% of recover cost of investment. Therefore, they must initiate to
purchase new machinery.
As per the above analysis it is suggested that Happy Meal limited must purchase new
machinery that will be beneficial in future.
(b) Benefits and limitations of each of differing investment appraisal techniques
Pay back period: It is capital budgeting techniques which is applied by the organisations
to calculate estimated period of time that occur in the procedure of recover cost of investment. It
is easy and simple method that can help to compute period of time in particular project. Such as,
Happy Meal limited wants to purchase new machine so for this apply this technique to calculate
the time period of recovery (Mitchell and Calabrese, 2019). There are mentioned benefits and
limitations of this technique such as:
Benefits
 Simplicity: This technique is simple to use and easily understand all the calculations of
proposed projects. This method use by the manager with using of calculator and calculate
pay back period of a project.
 Risk Focus: The analysis is concentrated on potential risk that arise in the future and
recover from investments. Therefore, the payback period utilised by the company to
compare different results by Payback period method.
Limitations
 The payback method is not concentrating on value of money and ignores profitability of
the business entity.
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 It gives importance to cash flow before the calculation of pay back but after the
calculation ignores cash flow (Morozko and Didenko, 2018).
Net Present value: In this method mainly calculated of present value of the proposed
project. The net cash flow consider at discounted rate of return to calculate accurate value of
selected project. When the project is presenting positive outcomes so project must be accepted
otherwise do not accepted. In the case of Ha[[y Meal Limited apply this technique to measure the
efficiency of an organisation.
Benefits
 This method is beneficial that helps to calculate the present value of particular project.
Along with it helps to determine the risk factors that arise in the selecting project in
future like operating risk and monetary risk. Thus, it becomes beneficial to analysis the
actual position of the project (Munge, Kimani and Ngugi, 2016).
 It recognises time value of money and straightforward to calculate (especially in
spreadsheet).
Limitations
 The main disadvantage of this project that most of the data calculated on assumption
basis so it is not related with actual project. Thus, it is not able to analysis the efficiency
of the projects effectively.
 This technique is not applicable on every type of projects because of have different
companies to determine the efficiency of such projects in specified period of time.
Accounting rate of return: It is a kind of decision making technique that helps to
business to select right project and provided that results. In this method calculate average net
income and rate of propose project. When accounting rate of return is calculated higher so that
time accepted the new project (Nkundabanyanga and et.al., 2017). According to this technique
the company use net profit to calculate accounting rate of return. In the context of Happy Meal
limited use this technique to analysis the efficiency of the project then take right decision.
Benefits
 It is easy method that simply applicable on new project. With the help of this method
managers can quickly see whether an investment opportunity may be enough to do
analysis.
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 This method supports in comparing a new project with another project that are cost
efficient with other projects are competitive in nature.
 It present clear perception of net income along with the earning after tax payments and
depreciation.
Limitations
 The main disadvantage of this method that it ignores value of time at the time of
calculation of rate of return. Thus it will impact on efficiency of the business in direct
manner (Sazonov and et.al., 2017).
 In this technique do not focus on the external factors that are related with the project and
important for the business.
Internal rate of return: It is a famous investment appraisal technique which is utilise by
the most of the organisation at the time of selection a project. Mainly this method based on the
discounted time frame that determine the NPV project after that characterize cash flow. In the
framework of Happy Meal Limited apply this method to take decision of acquire new machinery
of not. There are mentioned its benefits and limitations such as:
Benefits
 It is effective method of capital budgeting that present equal importance to all cash flows
not earlier and later. It presents the relation between different rate and present value to
present equal present value of cash outflow.
 In this method requires to calculate cost of capital due to without calculation of cost of
capital not possible to check profitability of the project (Yang, Ishtiaq and Anwar, 2018).
Limitations
 This method assumes that earnings are invested with the internal rate of return for spare
life of the project. When the average rate of return generated by the organisation is not
close to internal rate of return and that time profitability is not clear.
 The main limitation of this method that it provides importance only profitability and do
not focus on the compensate of capital expenditure. The main purpose of IRR method
that a project comparatively needed a length span of time for recouping the capital
expenditure (Yuniningsih, Pertiwi and Purwanto, 2019).
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CONCLUSION
As per the above report it has been concluded that financial management is important
term that followed by the every organisation to arrange all the financial activities in proper
manner. It focus on the financial framework of business and analysis all the financial activities.
The manager of the business utilise different techniques to determine the performance and
enhance the profitability. After the overall analysis, company decided to select option of Scrip
dividend and enhance the flexibility and liquidity. Moreover use different types of investment
appraisal techniques in order to take right decision from different options. These techniques are
payback period, NPV, ARR and IRR to analysis the profitability of operations.
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REFERENCES
Books and Journals
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the United Kingdom. British Journal of Criminology. 56(4). pp.709-728.
Ashmarina, S., Zotova, A. and Smolina, E., 2016. Implementation of financial sustainability in
organizations through valuation of financial leverage effect in Russian practice of
financial management. International journal of environmental & science education.
11(10). pp.3775-3782.
Bulturbayevich, M. B. and et.al., 2020. Modern features of financial management in small
businesses. International Engineering Journal For Research & Development. 5(4).
pp.5-5.
Georgieva, P. V., 2018. Genetic fuzzy system for financial management. Cybernetics and
Information Technologies. 18(2). pp.20-35.
Goryakin, Y. and et.al., 2017. Public financial management and health service delivery: a
literature review. London: Overseas Development Institute.
Grafova, T .O. and et.al., 2017. Tools of financial management of reputational risks.
Masharsky, A. and et.al., 2018. Anti-crisis financial management on energy enterprises as a
precondition of innovative conversion of the energy industry: case of Ukraine.
Mitchell, G. E. and Calabrese, T. D., 2019. Proverbs of nonprofit financial management. The
American Review of Public Administration. 49(6). pp.649-661.
Morozko, N. and Didenko, V., 2018. Financial management of small organizations based on a
cognitive approach.
Munge, M. N., Kimani, E. M. and Ngugi, D. G., 2016. Factors influencing financial
management in public secondary schools in Nakuru County, Kenya.
Nkundabanyanga, S. K. and et.al., 2017. The impact of financial management practices and
competitive advantage on the loan performance of MFIs. International Journal of Social
Economics.
Sazonov, S. and et.al., 2017. Theory and methodology of the financial management of the
regional supporting university. Journal of Advanced Research in Law and Economics.
8(1 (23)). p.211.
Yang, S., Ishtiaq, M. and Anwar, M., 2018. Enterprise risk management practices and firm
performance, the mediating role of competitive advantage and the moderating role of
financial literacy. Journal of Risk and Financial Management. 11(3). p.35.
Yuniningsih, Y., Pertiwi, T. and Purwanto, E., 2019. Fundamental factor of financial
management in determining company values. Management Science Letters. 9(2).
pp.205-216.
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