Financial Management Study Material

This study material covers various topics in Financial Management including Weighted Average Cost of Capital, Net Present Value, Budgeting, and more. It provides solutions to assignments and essays related to these topics. The document also discusses sources of funds for SMEs and corporate social responsibility.

FINANCIAL MANAGEMENT

TABLE OF CONTENTS
QUESTION 1...................................................................................................................................1
a) Weighted Average Cost of Capital .........................................................................................1
b) Net present Value ...................................................................................................................2
c) Memo.......................................................................................................................................3
QUESTION 2...................................................................................................................................3
a) Features of activity based costing system relative traditional costing system.........................3
b) Key decisions break even and cost profit volume analysis can be used for making...............4
QUESTION 3...................................................................................................................................5
a) Budgeting as tool used for aiding control and the performance management ........................5
b) Limitations of traditional budgeting. Beyond Budgeting improving the planning system.....6
QUESTION 4 ..................................................................................................................................7
Sources of funds for SMEs..........................................................................................................7
QUESTION 5...................................................................................................................................9
Corporate Social Responsibility including the benefits of stakeholders.....................................9
REFERENCES..............................................................................................................................11

QUESTION 1
a) Weighted Average Cost of Capital
Weighted Average Cost of Capital
Cost of Equity
Dividend Valuation method
Ke (D1/P0)+g
Dividend 0.15
Current Market Price 1.8
Growth 7.50%
Ke = (0.15*1.075/1.8)+0.075
16.46%
Cost of Preference Shares
DVM Preference Shares
Kp D/ P0
Dividend 0.07
Price 1.3
Kp = 0.07/1.3
5.38%
Cost of Debt
DVM for Loan Stock
Kd = I(1 – t)/MV
Interest 10.00%
Market Value 1.5
Kd = 0.10(1-0.25)/1.5
5.00%
Value of Company based
on market prices Capital Weight
Equity 50m * 1.8 = 90 0.78
Preference Share 6m * 1.3 = 7.8 0.07
Debt 12m * 1.5 18 0.16
Total 115.8 1
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WACC [keVe+KpVp+KdVd]
16.46*0.78 + 5.38*0.07 +
5*0.16
WACC 14.015
Interpretation
Weighted average cost of capital is a method used to calculate the cost of capital where
capital is weighted proportionally. Sources of the capital are equity, preference shares, bonds and
also long term debts used for financing the operations. It shows the cost of financing from
different sources to the company. There are different methods used for measuring the cost of
different securities such as dividend valuation methods, capital asset pricing method and others.
In the present case for calculating the cost of capital, market value of securities is used. Cost of
equity using valuation method is 16.46% which is high(Budhathoki and Rai, 2020). The cost of
preferred stocks is 5.38% and of debt is 5%. These are the costs to company for raising funds
from each of the sources. The WACC of company is 14.015% which is high. Company has to
make the adjustments for reducing the cost of capital of the business.
b) Net present Value
Net Present Value
Cost of Equipment 60000
Scrap Value 6000
Useful Life years 6
Cash Flows
Year Cash Flows
Pv@14.05
% PV of Cash Flows
1 21000 0.8768 18412.98
2 21000 0.7688 16144.65
3 21000 0.6741 14155.77
4 18000 0.5910 10638.77
5 8000 0.5182 4145.85
6 18000 0.4544 8179.01
Sum of Present Value (A) 71677.03
Initial Cost of Investment
(B) 60000
Net Present Value (A – B) 11677.03
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Interpretation
The net present value is method used for evaluating the viability of capital investments
for the company. It measures whether company will be able to cover the cost of investment from
the future cash flows. It brings the future cash flows at present value by discounting them using
discounting rate. The initial cost of equipment is 60000 with the scrap value of 6000 and useful
life of 6 years (Fernandez, 2019). For discounting the cash flows weighted average cost of
capital of 14.05% has been used. The net present value of equipments is computed as 11677.03
c) Memo
MEMO
To,
Board of Directors
ABC Ltd
Date: 22/1/21
Subject: Final Project Proposal
The proposal of company to acquire new equipment costing £60000 has been evaluated
using capital investment appraisal technique. It has been analysed from the net present value
method that project has positive NPV which means project will generate adequate profit for the
business. It will generate adequate returns adding value to the company. The future cash flows
are discounted by computing the cost of capital using dividend valuation method based on
market prices. Cost of capital is high of company which shows that cost of raising funds is high
which needs to be lowered down by making capital restructuring.
Considering the analysis for equipment it has been found that company should acquire
the equipment as it will be profitable for the company.
QUESTION 2
a) Features of activity based costing system relative traditional costing system
Calculating accurate manufacturing costs for every products is vital for decision-making
for company. The activity based and traditional costing method both are based over ABC and
traditional costing method for allocation of indirect costs to the products. The methods estimates
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overhead costs of production and also assign the costs to products based over cost driver rate.
Difference lies in complexity and accuracy of two methods. ABC is more accurate and assigns
the costs to the products based over arbitrary rating where traditional costing is simplistic but
also less accurate. ABC system is used for allocating the costs accurately on various resources
for making products. It increases number of cost pools for accumulating overhead costs where
traditional method only uses single cost pool and single predetermined rate over all the costs.
Number of pools are found on basis of cost driving activities (Alkaraan, 2017). Overhead costs
are charged to different products or jobs in proportion to cost driven activities in the place of
blanket rate based over direct labour cost or the direct machine hours. It also improves
traceability of different overhead costs that results in accurate and effective unit cost for decision
making.
Reasons for developing ABC system as alternative to traditional costing
Traditional method of costing assigns the overhead costs based over single rate. It made
cost allocations to activities at predetermined rate. ABC costing system assigns the overhead
costs based over different cost pool and activities which drive the cost. Traditional method is
useful only when manufacturing process is labour based and the overheads increases on the basis
of traditional activities like direct labour hours or machine hours. It was not effective for
organisations have multiple activities and operations (Kolawale and Grace, 2017). ABC costing
is very effective when manufacturing is technology driven and the overheads are increasing
based over different activities which differ over different activities which differ for every
product.
b) Key decisions break even and cost profit volume analysis can be used for making
Break Even Analysis
It is an effective tool that is used to analyse the number of products that needs to be sold
for variable and fixed cost of production. Identifying break even gives dynamic view of
relationship between the costs, sales and the profits. The break even analysis is point at which the
company has no profit no loss. Company starts earning profits after reaching the break even
point when it meets all the costs. It involves calculation of the contribution margin of products
by measuring the variable costs (Tran and Thao, 2020). It is an effective tool for financial
analysis.
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It is used for making sales decisions like number of products to be sold for meeting the
costs and number of products for earning the desired profits. It is also useful for making
decisions related to margin of safety. Based on Break even analysis it can make decisions
regarding the sales prices and also the variable costs. It can analyse the profits at different price
levels. It helps the management in taking cost decisions regarding reducing the costs or
increasing sales price. It will help in making the business more efficient and effective and
earning higher returns.
Limitations of Break even analysis
It is costs only analysis and do not tells bout sales of products at different prices. The
method also assumes the variable cost as constant per product of output and at least in range for
likely quantities of the sales. It is based over unrealistic assumption regarding fixed selling price.
Also the changes are seen in fixed costs with change in output (Almeida and Cunha, 2017). Sales
are always different from output and this thing has to be considered in the calculations. Break
even analysis should be seen more as the planning tool rather than decision-making tool.
QUESTION 3
a) Budgeting as tool used for aiding control and the performance management
On of the major element in financial activities include budgeting. Budgeting could be
described as method for resource allocation to different activities and departments of the
business. Budgeting is essential for the business to ensure that all the resources are allocated as
per the requirements of different departments. Budgeting is important planning tool used by the
business to make the effective utilisation of the existing resources. There are different methods
of preparing the budget which includes traditional, activity and zero based method of budgeting.
Firms use budget on the basis of their business's nature and size (Talmon and Faliszewski,
2019). The budgeting helps in analysing in advance about the resources required for carrying out
the different business activities and operations. If available resources are not sufficient it can
arrange for funds using most appropriate sources with minimal costs.
Budgeting is an effective and useful tool for controlling the costs and expenditures of the
business. Budgets provide the departments or divisions with specific budgets within which they
have to carry out the operations. It ensures that departments do not make exceed the given
budget. It saves unnecessary costs and expenditures of the business so that it could be used for
more productive uses. After the budget variance analysis is carried out to identify the variations
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between actual and budgeted outputs. On the basis of variance analysis report, management
frame the strategies for appropriate allocation and reducing the variances.
It also helps in performance evaluation and management. The budget target makes the
departments responsible to reach the objectives. Managers can take follow up of budgets
prepared for comparing actual outcomes with the managers. Any differences could be identified
in advance and corrections could be made timely (Chohan and Jacobs, 2018). They can
investigate the reasons of variations for taking the actions. Based on this managers can evaluate
the performance and establish procedures that will increase the efficiency of working process.
b) Limitations of traditional budgeting. Beyond Budgeting improving the planning system
Traditional method of budgeting is method used by number of companies for allocating
the resources and planning purposes. It is simple and easy method which is used from ancient
times. Though it is highly used but method is often criticised by the users for strong focus over
resource allocation and the inflexibility. It is not useful in complex business environment having
different business operations. The traditional method prepares budget based on previous budgets
of last year. It is kept as base for preparing the current year. Management analysing the current
trends make adjustments to the budget like inflation, demand and supply, economic environment.
It is not prepared by making complete analysis and just some adjustments are made to budget.
Traditional budget is prepared only by management and executives and made to comply by all
the departments. It makes disconnection with actual strategic plan of business and results in high
variations between the budgeted figures and actual outcomes. The traditional budgeting also do
not allow the company to assess the actual activities and is inefficient in organisation having
different process activities and those process that have high degree of changes. It is useful only
when production process do not see any changes.
Beyond Budgeting
Beyond budgeting refers to method of abolishing the process of traditional budgeting for
eventually improving the management control over the organisation. Abandoning the traditional
budgeting process company aim at establishing highly decentralised system and the adaptive sets
for management process. It involves re- examining the costs and expenditures about how they
could be managed better and improved (May, 2017). It focus over binding the people for a
common cause. It also focuses over shared values and making sound judgements for the benefit
of organisation in place of making rigid rules and regulations for the business. Beyond budgeting
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analyses all the activities and the resources required for carrying out that process so that
resources could be allocated more effectively without sacrificing the quality of products and
services. It aims at improvising the products and services with optimum utilisation of the
business resources.
QUESTION 4
Sources of funds for SMEs
Financing is the process of providing funds to business to carry out its operation
effectively. In the current era Small Medium Enterprise (SME) can reach full potential only if
they get finance to start, sustain and grow. There are various sources through which SME can get
funds to meet its business objectives. These principal means through which small and medium
enterprise can get finance are Business angels, factoring and invoicing, leasing, bank finance,
venture capital, friends and family.
Own Funds
Business owners can bring their own funds for carrying out the operations of business.
These funds could be borrowed from friends or family. These could also be the personal savings
of owners that could be brought for business. The liability of own funds is unlimited and puts
extra pressure to generate adequate profits for making repayments if funds are borrowed from
others.
Angel Investors
Business angel refers to individuals that are willing to invest in SMEs by taking risk.
This option can be very useful for small and medium scale enterprise as they will get expertise in
turn of part of business (Shrotriya, 2019). These type of angel partners can provide contacts to
small businesses which will help the organization to grow. Angel partners can serve various
benefits to medium scale firm which includes minimal paperwork, building strategic ideas,
guidance and support. This option of financing might affect business concern by expecting high
share of organization, unclear roles and terms can be very ambiguous.
Bank Finance
For sourcing fund small and medium business can use option of bank financing. Such
organisation usually does not use this financing way as enterprise may not be able to pay the loan
back in case of medium term and long term. Moreover small business does not have such
collateral property in against of which they can take loan. Business units prefer short term
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financing from bank in form of overdraft which ease their process of sourcing easy and flexible.
SMEs can take various benefits from this option of sourcing fund like increasing reputation of
company as well as it gives competitive edge advantage.
Venture Capital
venture capital is a source of finance that allow small and medium scale business to start
their organisation. It generally comes from financial institution, investment bank and well off
investors. It is necessary that venture capital take form in monetary, it can also come in way of
technicals and managerial proposal. It is good source of finance for SME as they get many
benefits through this options such as valuable guidance, helpful in building system and relation,
easy expansion etc. there are disadvantages also that business face are weakening of ownership
and control and it may also result in lead undervaluation
Factoring and Invoice Discounting
Both of these option helps organization to get fund in against of documents related to
outstanding receivables. The biggest benefit that organization get through this option is their
outstanding receivables increases as business concern grows which allow them to factor or
discount invoicing more than previous (Huang, Yang and Tu, 2020). However it is expensive
from overdraft but can be use by SMEs in case of urgency. It might decrease its profit that can
make it more volatile.
Leasing
It is good option to lease an asset rather than buying it as it reduced requirement of
capital. It provides benefits to enterprise of maintaining its cash outflow, low capital expenditure,
tax benefits and better planning (Gong and et.al., 2020). Some drawbacks that SMEs face due to
leasing includes maintenance of assets, no ownership and lease expenses.
Supply chain Financing
Supply chain financing is technique and tool used by banks to control capital invested to
minimizes risk for involved parties. It provides merits of good buyer-suppler
relationship,increased liquidity, improved efficiency, cash flow control,good credit rating and
flexibility (Liu, Zhang and Xiong). On other side it has demerit like mismanage and inadequate
implementation which affect the organisation negatively.
Above mentioned are the means of finance for small and medium enterprise which help
business to start their operations, sustain in market and grow in industry. These options of
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sourcing fund have its own advantages and disadvantage that impact concern enterprise in both
positive and negative manner.
QUESTION 5
Corporate Social Responsibility including the benefits of stakeholders
Corporate social responsibility refers to that corporate activates that are taken by
businesses to influence society and stakeholders positively. Stakeholders are those who have
interest in operations of organisation and get affected from their decision-making process.
Stakeholders include employees, customers, society etc.
Responsibility related to employees
First responsibility of any organization is to generate employment opportunities. Keeping
employees happy by giving them derivable remuneration is part of corporate responsibility of
business (Abbas, 2020). In addition to this providing clean, safe and suitable environment to
employees is primary responsibility of organization. There are some rules and regulations also
that government has made regarding employment generation which every enterprise need to
fulfil.
Responsibility related to customers
To be a successful organization fulfilling customers needs become essential activity for
business. Moreover, providing goods and service with standard quality is primary responsibility
of every business. It also helps organisation to attract customers attention by making them
believe that organization is concern about their health. By completing corporate responsibility
company gain trust of customers as well as.
Responsibility to society
Business provide job, service and products to society so it must be adhered responsibility
related to it. The tax that company pay are used by government for formation of schools, better
infrastructure and hospital. There are various companies that also take initiation for charity and
formation of infrastructure that are essential for day to day life of common people. Some
responsibilities include activities of legal accountability, public transparency and environmental
performance in turn which allow company to use resources for production of goods. Company
can not perform good until it fulfil its corporate responsibility as it is dependent on society for
employees, customers, suppliers, investors, lenders etc.
Responsibility of environment protection
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Business is responsible to accomplishing its duty of environment protection by taking
major actions. Resources of world are limited so using them in appropriate manner become must
for enterprises. Resources like plants, animals, metals etc. should not be use abundantly so that
upcoming generation can utilize them (Ali, Danish and Asrar‐ul‐Haq, 2020). Stakeholders
support those businesses that adhere its responsibility related to environment as people are aware
of nature's importance. Government of every company have made strict standards affiliated to
environment so that company feel fear of strict action. Many parties have conducted research on
importance of environment which encouraged companies to spread less pollution.
These are areas where firm should focus for fulfilling social responsibility to maintain
interest of stakeholders in organisation and to cope up with government regulations related to
corporate obligation.
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REFERENCES
Books and Journals
Abbas, J., 2020. Impact of total quality management on corporate green performance through the
mediating role of corporate social responsibility. Journal of Cleaner Production. 242.
p.118458.
Ali, H. Y., Danish, R. Q. and Asrar‐ul‐Haq, M., 2020. How corporate social responsibility boosts
firm financial performance: The mediating role of corporate image and customer
satisfaction. Corporate Social Responsibility and Environmental Management. 27(1).
pp.166-177.
Alkaraan, F., 2017. Strategic investment appraisal: multidisciplinary perspectives. In Advances
in Mergers and Acquisitions. Emerald Publishing Limited.
Almeida, A. and Cunha, J., 2017. The implementation of an Activity-Based Costing (ABC)
system in a manufacturing company. Procedia manufacturing. 13. pp.932-939.
Brown, R. and Rocha, A., 2020. Entrepreneurial uncertainty during the Covid-19 crisis:
Mapping the temporal dynamics of entrepreneurial finance. Journal of Business
Venturing Insights. 14. p.e00174.
Budhathoki, P.B. and Rai, C.K., 2020. The Impact of the Debt Ratio, Total Assets, and Earning
Growth Rate on WACC: Evidence from Nepalese Commercial Banks. Asian Journal of
Economics, Business and Accounting. pp.16-23.
Chohan, U.W. and Jacobs, K., 2018. Public Value as Rhetoric: a budgeting
approach. International Journal of Public Administration, 41(15), pp.1217-1227.
Fernandez, P., 2019. WACC and CAPM according to Utilities Regulators: Confusions, Errors
and Inconsistencies. Errors and Inconsistencies (February 19, 2019).
Gong, D. and et.al., 2020. Who benefits from online financing? A sharing economy E-tailing
platform perspective. International Journal of Production Economics. 222. p.107490.
Huang, J., Yang, W. and Tu, Y., 2020. Financing mode decision in a supply chain with financial
constraint. International Journal of Production Economics. 220. p.107441.
Kolawale, O.A. and Grace, O.O.B., 2017. Assessment of viability appraisal practice by estate
surveyors and valuers in lagos metropolis, Nigeria. International Journal of Built
Environment and Sustainability. 4(1).
Liu, W., Zhang, Y. and Xiong, W., 2020. Financing the Belt and Road Initiative. Eurasian
Geography and Economics. 61(2). pp.137-145.
May, A.U., 2017. Traditional budgeting in today’s business environment. Journal of Applied
Finance & Banking. 7(3). pp.111-120.
Shrotriya, D. V., 2019. Internal sources of finance for business organizations. International
Journal of Research and Analytical Reviews. 6(2). pp.933-940.
Talmon, N. and Faliszewski, P., 2019, July. A framework for approval-based budgeting methods.
In Proceedings of the AAAI Conference on Artificial Intelligence (Vol. 33, No. 01, pp.
2181-2188).
Tran, T. and Thao, N., 2020. Factors affecting the application of ABC costing method in
manufacturing firms in Vietnam. Management Science Letters. 10(11). pp.2625-2634.
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