Financial Management: Valuation Methods and Capital Budgeting Tools

Financial Management

Table of Contents
INTRODUCTION...........................................................................................................................3
Question 2 – Mergers and Takeovers..............................................................................................3
a) Price/earnings ratio.................................................................................................................3
b) Dividend valuation method.....................................................................................................4
c) Discounted cash flow method.................................................................................................5
d. Critical review.........................................................................................................................6
Question 3........................................................................................................................................7
a. Calculating capital budgeting tool ..........................................................................................7
b. Critically evaluating merits & demerits of different capital budgeting tools .........................9
CONCLUSION .............................................................................................................................13
REFERENCES..............................................................................................................................14

INTRODUCTION
FM refers to planning, directing, organizing & controlling financial activities like
acquisition and use of funds of an entity. It means as application of the general principles of
management to the financial resources of company. It acts as the most important part of an
organization as all the important decisions are based on FM such as investment, dividend and
financing decision. The present report is based on different aspects of FM which include
computation of P/E ratio and valuation of dividend and asset. Furthermore, the report highlights
different methods of capital budgeting which helps in analysing the suitability of project.
Moreover, benefits and limitation of investment appraisal tools is also been presented in the
study.
Question 2 – Mergers and Takeovers
a) Price/earnings ratio
The price earnings ratio is the most common and popular method for the purpose of
valuation of the business. Under this approach, the price is identified using PER of the other
similar quoted business in the industry. The PER is evaluated by dividing the present MP per
share of the entity with its earnings per share (EPS). It helps in determining how much money
the investor is willing to pay for the company’s earnings (Ivanovski, Narasanov and Ivanovska,
2018). The companies with the higher earnings growth prospects mainly carry higher price
earnings ratio, this is because of the reason that these business entities are in the position to offer
return to its investors very quickly and higher percentage return in respect to the investment
which will be through offering dividend, rise in the share price or both. For instance, a company
having the price earnings ratio of 15 means it is selling for 15 times of its income and in simple
and easy terms, the investors are in the position to pay £15 for every £1 of present or the coming
years income (JUŠKEVIČIŪTĖ, 2017). In case of mergers and acquisition, using the price
earnings ratio for valuation, it is considered to be very useful as it can be used in comparing the
ratio with the various different business entity in the same industry or even against the historical
values of the company. But this ratio can be easily manipulated by the company as per the
requirement suing the accounting practices.

MPS £3.89
EPS £0.21
P/E ratio of Aztec (A) 18.52
Distributable earnings £40.4
number of shares 147
EPS of trojan (B) £0.27
Value per share of Trojan (A * B) £5.0004
Total market value £735.06
Statement showing valuation using price earnings ratio
As per the given case, the value of Trojan plc is £735.06 which is derived using the price
earning ratio. The market value is calculated by multiplying the number of shares with the per
share value of the Trojan plc.
b) Dividend valuation method
Under this valuation method, the dividend amount and the value of the stock is assumed
to be growing at the constant rate or in simple words, the dividend paid by the company will
grow at the constant percentage. This valuation method is mainly appropriate for the businesses
which increases their dividend by a fixed percentage every year. This method is very simple to
apply and is mainly suitable for the businesses with the stable growth along with the established
dividend pay-out ratios (Blanken, 2019). Investors can compare the businesses against the other
industries with the help of this model. Using this model, requires current dividend paid, the
expected rate of return and the growth rate. It actually establishes the relationship with these
three. Other than the above stated assumption, there are other assumptions as well, that is,
company’s growth is constant, financial leverage remains the same and the company’s free cash
flow is paid as the dividend.