Financial Management: A Comprehensive Review

This assignment provides a detailed review of financial management, covering various topics such as accounting risk, return, dividend policy, payback period, and more. It includes references to academic papers, books, and online resources, making it a valuable resource for students and professionals seeking to improve their understanding of financial management.

Financial Management

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................2
MAIN BODY...................................................................................................................................3
QUESTION 1...................................................................................................................................3
a. Fair share price for Planet's shares..........................................................................................3
b. Calculating new share price for Planet's share........................................................................3
c. Dividend growth model use for valuing shares and problem faced........................................4
QUESTION 3. Investment Appraisal Techniques...........................................................................5
1. Calculating following techniques along with recommendations............................................5
....................................................................................................................................................5
a. Payback period........................................................................................................................5
b. Computation of Accounting Rate of Return...........................................................................6
c. Computation of Net Present Value.........................................................................................6
d. Internal rate of return (IRR)....................................................................................................7
2. Benefits and limitations of various Investment appraisal techniques.....................................8
CONCLUSION..............................................................................................................................11
REFERENCES..............................................................................................................................12

INTRODUCTION
The term Financial Management is a process concerned with planning, organising,
controlling, monitoring and directing of resources related to finance. Every company should have
adequate and effective management of finance related activities like raising & effective
utilization of funds, risk associated, making of accounting policies & records, financial payments
& other expenses. The report will discuss about Dividend Policy as adopted by Planet for
distributing the dividend amount to its shareholders. Also, the report will discuss that how value
of shares can be calculated with the help of dividend growth model. At last the report will
provide information related to the Investment Appraisal Techniques such as Payback period, Net
present value etc. available for use by Lovewell Limited Company which is engaged in business
of food manufacturing for purchasing new machine. The report will also disclose brief
recommendation made to Lovewell Limited along with benefits and limitations of various
investment appraisal techniques.
MAIN BODY
QUESTION 1
a. Fair share price for Planet's shares.
Value of stock = D1 / (k - g)
K = required rate of return
G = Expected growth rate in dividend
D1 = expected dividend per share
Particulars Figures
Current dividend £0.20
Expected growth rate 12%
Required rate of return 14%
The price of the stock is £9.03
Fair share price is the selling price of the shares on which the buyer shows willingness to
buy and seller reflects the willingness to sell. It also represents the value of the assets and
liabilities of the financial statements of the company (Horner, 2018). It is used for the making the

valuation of the shares. It becomes important for the organization to value the share at the fair
price so that current value of the shares in the market can be evaluated by the users and the
decision regarding the investment can be made by the external users.
The average expected growth return for the planet shares is resulted as 12% and the rate
of return is generated equals to 14%. Investments in equity share, when no significant influence
or control is present, then the costs are recorded and adjusted to the fair value. The dividend
policy relates with the explicit or implicit decisions of the directors of the board and regarding
the residual earning of the business. These earnings are distributed to the owners or the
shareholders of the company (Horner, 2018). Dividend policy decisions are considered as the
financing decision because the income of the enterprise act as an important source of funding
that are available to the corporate.
b. Calculating new share price for Planet's share.
Particulars Figures
Current dividend £0.20
Expected growth rate 12%
Required rate of return 15%
Stock ‘s price (fair value) £5.76
In case of Planet company, the company has decided to increase the debt level in the
business. It will result to increase in the financial risk of the business associated with the equity
shares as the company will have to distribute its profit with debenture holder also in form of
interest (Renneboog and Szilagyi, 2015). It has led to increase in the required rate of return of
planet’s shareholders to 15.4 per cent. The current dividend distributed is $0.20 to the
shareholders of Planet. The expected growth rate of shareholders of the planet company for their
proportion of shares is 12% and the required rate of return is 14%. The new share price for
Planet's share calculated is $5.76.
c. Dividend growth model use for valuing shares and problem faced.
Dividend growth model is also known as The Gordon Growth Model. This model helps
in assessing the true intrinsic value of share of the company (Kibet, Jagongo and Ndede, 2016).

The dividend growth model is used for determining the intrinsic value of company's stock,
securities, share on the basis of a future dividend rate which is growing at the constant rate.
The Dividend Growth Model helps in valuing the stock or share of the company by
making use of an assumption of constant growth rate of dividend or interest concept which is
used by the company for making payment to its preference and equity shareholders (LaRiviere,
McMahon and Neilson, 2016). The main factor on which emphasizes is made in the model are:
1. Dividends per share – The amount of profit which the company distributes as dividend
with its shareholder on per share acquired.
2. Growth rate of dividend – The rate at which dividend to be distributed to shareholder is
growing either at constant, increasing rate.
3. Rate of return – The return which the shareholder is expecting to be receive on their
proportion of holding.
Assumptions on which the dividend growth model are as follows:-
1. The Company is growing at a constant rate.
2. The Company is having a stable leverage related to finance or no financial leverage is
involves (Lakshmi and Azhagaiah, 2015).
3. The lifespan of the company is indefinite.
4. The required rate of return always remains constant for the company.
5. The required rate of return is always greater than the growth rate.
Problems with using the dividend growth model as a way of valuing shares are as follows:
1. It works on the assumption that company is gets its funds financed only with the help of the
retained earnings. It doesn't rely on external funding options such as: raising of share debt or
equity.
2. The Dividend Growth Model is applicable only for the company having equity investment. It
assumes that the rate of returns is constant but can decrease with increase in the investment level
(Lakshmi and Azhagaiah, 2015).
3. The cost of capital of the company always remains constant which is not possible because it
ignores risk factor associated with the business thereby having negative effect on the firm’s value
and share price which in turn affects the profit part of shareholders.

QUESTION 3. Investment Appraisal Techniques
1. Calculating following techniques along with recommendations.
a. Payback period
Payback period refers to the time required for gaining back the cost incurred as initial
investment. Here, the payback period of Lovewell Limited is 3 years and 8 months which means
that company can recover its amount in this time period.
Years
Net cash flow (in
£) Cumulative cash flows (in £)
1 72500 72500
2 72500 145000
3 72500 217500
4 72500 290000
5 72500 362500
6 72500 435000
Payback
period
3 + (275000 – 217500) / 72500
= 3.8 years or 3 years and 8 months
b. Computation of Accounting Rate of Return.
Accounting Rate of Return is a term which helps in determining the percentage rate of
return which a project will provide annually. The rate at which Lovewell Limited will get annual
return on the purchase of machine is 45.85% which will improves its production function and
operational efficiency thereby leading to growth and increase in profit margin of the company.
Years Cash inflows
(in £)
Cash outflows
(in £)
Depreciation
(in £) EBIT (in £) Net cash flow Add:
depreciation (in £)
1 85000 12500 38958 33542 72500
2 85000 12500 38958 33542 72500
3 85000 12500 38958 33542 72500
4 85000 12500 38958 33542 72500
5 85000 12500 38958 33542 72500
6 85000 12500 38958 33542 72500
Average
profit 72500

Average
investment 158125
Accounting
Rate of
Return
72500 / 158125 * 100=
45.85%
Average investment = (initial investment + depreciation value) / 2
= (£275000 – £41250) / 2
= 158125
c. Computation of Net Present Value.
Net present Value provides the difference between the present value of total cash
inflows and total cash outflow for a specified period of time. The net present value of
Lovewell limited is £23077 which is positive that means the revenues of the company is
much higher than the costs incurred.
Years
Cash
inflows
(in £)
Cash
outflows
(in £)
Depreciation
(in £)
EBIT(in
£)
[Cash
inflow –
(cash
outflow +
depreciat
ion)
Net cash flow:
Add
depreciation
(in £)
PV factor
@ 12%
Discounted
cash flow (in
£)
1 85000 12500 38958 33542 72500 0.893 64732
2 85000 12500 38958 33542 72500 0.797 57797
3 85000 12500 38958 33542 72500 0.712 51604
4 85000 12500 38958 33542 72500 0.636 46075
5 85000 12500 38958 33542 72500 0.567 41138
6 85000 12500 38958 33542 72500 0.507 36731
Sum of
discounted
cash flows
298077
Less: initial
investment 275000
Net
present
value
23077

Computation of depreciation
 Cost of new machine: £275000
 Residual value: 15% of the original cost of the machine
= 275000 * 15%
= £41250
 Life of the machine: 6 years
Depreciation: Cost – Scrap value / expected life of the machine
= (£275000 – £41250) / 6
= £38958.33
d. Internal rate of return (IRR).
Internal rate of return helps in assessing the worth of project. It measures the return rate
on projected cash flows generated by making capital investment. By making investment in the
purchase of machine, the company will get 14.92% return.
Years Cash inflows (in £)
0 -275000
1 72500
2 72500
3 72500
4 72500
5 72500
6 72500
Internal rate of
return 14.92%
Feasibility of acquiring machine – A project or investment is considered as favourable when the
payback period is less than the expected time period for recovering the amount of initial
investment and the other investment appraisal techniques i.e. Accounting Rate of return, Net
present value and Internal rate of return is high.

In this case, the payback period of Lovewell Limited is 3 years and 8 months which
depicts that it company makes investment in purchasing of new machine than it will be able to
recover the cost involves in purchasing within 3 years and 8 months.
Also, the accounting rate of return of the company is 45.85% which shows that company
will get such percentage amount as the rate of return on purchase of machine.
The net present value of the company is also positive which shows that it will be
favorable for the company to acquire new machine as it will lead to increase in the productivity
as well as profitability of the company thereby improving the performance of the company as a
whole.
When it comes to internal rate of return, Lovewell Limited is having 14.92%. It shows
that company will get 14.92% rate of return when it will make capital investment in acquisition
of new machine.
Thus, it can be said that on purchasing of new machine, Lovewell Limited can recover its
cost in 3.8 year with positive net present value of £23077 having 14.92% and 45.85% as internal
and accounting rate of return respectively.
2. Benefits and limitations of various Investment appraisal techniques.
Lovewell Limited is engaged in food manufacturing business, who wants to purchase a
new machine for improving its overall productivity as well as operational efficiency. Thus,
various Investment appraisal techniques are available for acquiring machine such as payback
period, net present value, accounting rate of return and internal rate of return.
Benefits of Investment appraisal techniques are as follows:
1. Payback period – The term payback period simply defined the time required for
recovering the amount of investment made in the initial period i.e. initial investment. It
evaluates the length of time which is needed so as to recover the cost of an initial investment
(Lin, Chang and Chung, 2015). The longer payback period is not considered desirable for
investment purpose.
Benefits of payback period is as follows:
1. It provides importance of liquidity factor as required for making decision related to
investment proposals.

2. It mainly focuses on risk. The project having short period is less risky as compared to
longer period.
3. With the help of payback period the decision making process becomes easy related to
investment as lower payback period is considered better for the investment.
4. Pay-back period method is very simple and easy to calculate and also provides ease in
understanding with the help of formula: Pay-back period = Cost of project / Net annual
cash inflows.
Limitations of payback period is as follows:
1. Payback period only emphasizes on liquidity and not on profitability.
2. The most important limitation of payback period is that time value of money is not
recognized for the project.
3. Another limitation of this technique is that it doesn't take into consideration the amount
of cash inflow which is generated after payback period.
2. Accounting Rate of Return – The term accounting rate of return is also known as
Average rate of return which defines the rate of return to be received on investment made
or on purchase of any asset in comparison with the cost incurred for initial investment
(De Villiers, 2015). It helps in determining the investment profitability.
Benefits of Accounting Rate of return:
1. This helps in measuring the profitability level as well as the existing performance
level of the business organization.
2. It is easy to calculate Accounting Rate of Return for different project and investment
with the help of formula:
Accounting Rate of Return = (Average Net Income/Average Investment) x 100
3. It helps in recognizing the earnings after tax and depreciation amount, also known as
the net earnings or income of the business which plays an important role in
investment appraisal.
4. With the help of accounting rate of return, comparison of new project with the cost or
similar competitive project can be made.
Limitation of Accounting Rate of return:

1. It doesn't consider time factor related to selection of various funds use. Accounting
rate of return doesn't focus on the time value of funds.
2. It doesn't take into consideration the negative impact of external factors on the
profitability level of the business project.
3. When investment is made in form of instalments of two or more at different times,
this method cannot evaluate the worth of project.
3. Net Present Value – It shows the difference between the present value of cash inflow
and present value of cash outflow for a definite period of time (Dash and Motukuri,
2018). Net present value can be used in making investment planning which further helps
in assessing the success or profitability situation of a project or investment.
Benefits of Net present value:
1. It helps in discounting future year cash flow back to the present for ascertaining the worth of
project.
2. With the help of net present value the value related to both shareholders and firm can be
maximize.
3. In project assessment, the profitability factor and risk factor are taken into consideration at
high priority.
Limitations of Net present value:
1. Net present value doesn't provide appropriate calculation of the discount rate as it is difficult
to calculate.
2. Sometimes, net present value doesn't provide the adequate or correct decision making in case
of unequal life of projects.
3. It is of no use when comparison is made between projects having differing investment
amounts.
4. Internal rate of return – It is defined as that rate of interest at which the company's net
present value of all the positive cash flows including the negative, from the investment is
equal to zero amount (Mellichamp, 2017). This investment appraisal technique of
Internal rate of return helps in evaluating or assessing the benefits or profits of a
particular project or investment.

Benefits of Internal Rate of return:
1. It can be used when annual cash flow is both even and uneven by considering time
value of money.
2. Internal Rate of Return considers both the total cash inflow and outflows for definite
period of time.
3. It emphasizes on maximization of profit level as well as wealth of the shareholders.
Limitation of Internal Rate of return:
1. It is only concerned with projected cash flows which is created with the help of
injection of capital rather than considering future costs which can affect profit.
2. The most important limitation of this technique is that it doesn't consider the project
size when making comparison between two projects.
3. It compares cash flow of project with project cost only. It doesn't consider factors such
as future costs, duration of project etc.
CONCLUSION
From the above report it can be concluded that financial management is a process which
is concerned with the effective management of financial activities of the business organization.
The report has discussed about the dividend policy of Planet company. It has also shown the
calculation of fair share price of Planet's share with the past four years’ dividends per share
distribution. Further the report has shown the calculation of new share value of planet's share
after the increase in its debt level which has led to increase in Planet’s shareholders price of up to
15.4 per cent return. Also, the report has discussed that how dividend policy is used in valuing
share price. Lovewell Limited, a food manufacturer is thinking of acquiring new machine for
which various investment appraisal techniques such as payback period, accounting rate of return,
net present value and internal rate of return has been calculated to assess the feasibility of
purchasing such machine. The report has discussed the benefits of payback period, accounting
rate of return, net present value and internal rate of return along with their limitations.

REFERENCES
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Dash, M. and Motukuri, T., 2018. A Model of the Net Present Value of “Zero-Interest”
Instalment Schemes. Journal of Applied Management and Investments. 7(4). pp.179-184.
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De Villiers, J.U., 2015. Inflation, asset structure and the discrepancy between accounting and
true return (Doctoral dissertation).
Finkler, S. A., Smith, D. L. and Calabrese, T.D., 2018.Financial management for public, health,
and not-for-profit organizations. CQ Press.
Gaspars-Wieloch, H., 2017. Project net present value estimation under uncertainty. Central
European Journal of Operations Research, pp.1-19.
Horner, M., 2018. Share value. Construction Journal, pp.12-13.
Kibet, W. T., Jagongo, A. O. and Ndede, F. W. S., 2016. Effects of dividend policy on share
price of firms listed at the Nairobi Securities Exchange, Kenya. Research journal of finance
and accounting. 8(7). pp.220-230.
Lakshmi, S. and Azhagaiah, R., 2015. The Impact of Dividend Policy on Shareholders’ Wealth
before and After Financial Melt down: Evidence from FMCG Sector in India. Financial
Risk and Management Reviews.1(1). pp.8-26.
LaRiviere, J., McMahon, M. and Neilson, W., 2016. Shareholder protection and dividend policy:
An experimental analysis of agency costs. In University of Tennessee-Knoxville and
University of Arkansas Little Rock Working Paper.
Lin, W. M., Chang, K. C. and Chung, K. M., 2015. Payback period for residential solar water
heaters in Taiwan. Renewable and Sustainable Energy Reviews.41. pp.901-906.
McKinney, J. B., 2015. Effective financial management in public and nonprofit agencies. ABC-
CLIO.
Mellichamp, D. A., 2017. Internal rate of return: Good and bad features, and a new way of
interpreting the historic measure. Computers & Chemical Engineering.106. pp.396-406.

Renneboog, L. and Szilagyi, P. G., 2015. How relevant is dividend policy under low shareholder
protection?. Journal of International Financial Markets, Institutions and Money.
Online
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