Financial Management: Calculation of WACC, Investment Appraisal Techniques

Financial
Management

Table of Contents
INTRODUCTION...........................................................................................................................1
QUESTION 1...................................................................................................................................1
a. Calculation related to book and market value of cost of capital..............................................1
b. Reflection on the changes and comments on the projects of finance director.........................4
c. Minimisation of weighted average cost of capital by integrating a sensible level of gearing
into their capital structure............................................................................................................5
d. Effects of short termism on bankruptcy and the agency problem...........................................5
QUESTION 3...................................................................................................................................5
a. Different investment appraisal technique's calculations along with recommendations...........5
b. Benefits and limitations of all the investment appraisal techniques......................................10
CONCLUSION..............................................................................................................................11
REFERENCES..............................................................................................................................12

INTRODUCTION
Financial management can be defined as the process of managing all the resources which
are used by an organisation to carry out operational activities. If top level executives of a
company are not able to pay attention towards the same then it may result in inappropriate
execution of operations. Present report is based financial management in different scenarios
(Antonopoulos and Hall, 2015). For the completion of the same question 1st and 3rd are selected.
Different topics which are covered in this assignment are calculation of WACC on market, book
and proposed changes value, effect of short termism on bankruptcy and agency problem. Along
with this, calculation for different investment appraisal techniques are also done in this report to
make sure that the management should investment should be made in the project or not.
QUESTION 1
a. Calculation related to book and market value of cost of capital
Capital structure can be defined as the way in which an organisation manages all its
securities and use them to execute business operations. For the purpose of evaluating cost of all
its elements such as equities, debts, binds, preference shares etc. cost of capital is followed. It is
an approach which is used to determine opportunity cost of an investment which is being
planned by an organisation (Ashmarina, Zotova and Smolina, 2016). Finance director of Kadlex
Plc have analysed that WACC of the organisation is very low therefore she has planned to issue
more debts in the markets so that funds could be acquired. For the purpose of determining effects
of such changes following calculations are done:
Growth calculation:
From year 1st to 5th growths are 21, 23, 25, 27 and 28p respectively. Its calculation is as
follows:
Formula for calculations: Sn = S0*(1+g)n
28 = 21 * (1 + g)4
28 / 21 = (1 + g)4
1.33 = (1 + g)4
(1.33)0.25= (1 + g)
g = 1 – 1.0757
= 0.0757 or 7.57%
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Here, Sn = Last dividend
S0 = First dividend
n = number of years
g = growth
Calculation of growth rate for all the securities:
Cost of irredeemable bonds:
Formula for calculations: Kd = [ j * (1 – CT) ] * (Po / Pn)
Kd = [ 0.10 * (1 – 0.30)] * (100 / 107)
= 0.0654 or 6.54%
Here, Kd = Cost of Irredeemable Bonds
j = Rate of interest on bonds
CT = Rate of Corporate tax rate
P0 = Initial Price
Pn = Current Price
Cots of equities:
Formula for calculations: Ke = [Sn * (1 + g) + g ]) / P0
Ke = [28 * (1 + 0.075) + 0.075] / 2.65
= (28 * 1.15) / 2.65
=12.15%
Here, Ke = Cost of Equity
Sn = First dividend
g = Growth rate
P0 = Current share price of equity shares excluding dividend
Cost of preference share:
Formula for calculations: Kp= (j)/Pf
= 7 / 75
= 0.0933 or 9.33%
Here, Kp = Total cost of Preference Shares
j = Dividend on preference shares
Pf = Current [rice of preference share excluding dividend
Calculations of WACC on book and market value are as follows:
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