Capital Structure and Its Impact

This assignment delves into the crucial topic of capital structure in finance. It examines the definition, key components, and various theoretical frameworks surrounding capital structure decisions. The assignment analyzes how different factors influence a company's choice of debt and equity financing, exploring its impact on financial performance, risk levels, and overall value. It also considers the role of market conditions, industry characteristics, and corporate governance in shaping capital structure strategies.

Financial Management

TABLE OF CONTENTS
TASK 1............................................................................................................................................1
INTRODUCTION..................................................................................................................1
TASK 2............................................................................................................................................2
Importance of capital structure and optimum capital structure in organisation.....................2
TASK 3............................................................................................................................................3
Explaining the term rights issues and how company derive theoretical ex-rights price........3
TASK 4............................................................................................................................................4
Calculation of price the rights issued would be traded...........................................................4
TASK 5............................................................................................................................................4
Explaining five methods of raising capital.............................................................................4
TASK 6............................................................................................................................................6
Investment appraisal techniques for choosing project............................................................6
TASK 7..........................................................................................................................................13
Factors to be consider before arriving at final decision on a project....................................13
CONCLUSION AND RECCOMENDATIONS...........................................................................16
REFERENCES..............................................................................................................................16

TASK 1
INTRODUCTION
Finance plays crucial role in the company to achieve goals in effective way. Financial
management is required to be managed in optimum manner so that firm may extract benefits and
accomplish production and various other tasks in effectual way. Present report deals with two
organisations aiming to expand their operations by initiating funds and to achieve goals with
much ease. Firstly, Victory Ltd is manufacturing sector and is planning for expansion with the
help of rights issues and accomplishing finance in the best possible manner. Furthermore,
various methods of raising capital are highlighted such as retained earnings, share capital, bank
loan, sale of assets, angel investors etc. which are helpful for company in raising finance in
effectual way.
Furthermore, importance of capital structure in the business in attaining long term and
short term requirements is listed in this report. Importance of having right mixture of capital is
also explained and as such, company should have balanced capital structure by initiating debt
and equity in equal proportion. This will help company to attain high production in the best
possible way. Thus, optimum mix of capital structure is utmost required in the organisation.
Furthermore, theoretical ex-rights price for Victory Ltd is also calculated and as such, it is good
source of generating funds by initiating discount on it and existing shares can be sold in a better
way. Thus, expansion may be made by the company in effectual manner.
On the other hand, report highlights Transparent view Plc which is engaged in providing
advance solutions to transport operators in foggy conditions. It is planning to invest in the project
so that it may provide services in the best possible manner. It has three projects and planning for
selecting best alternative out of it. The capital investment appraisal techniques such as NPV,
IRR, ARR and payback period are calculated in order to select best alternative yielding good
returns to company to accomplish objectives in effectual manner. These methods of investment
appraisal provides clarity to business whether to invest in the project or not. Thus, company can
easily take advantage of these techniques to invest money in maximum return generating project.
Furthermore, recommendation is also provided to select best option out of the available option in
the report. Apart from this, there are various factors that are required to be assessed by company
before making final decision to make investment in the project. The factors are also highlighted
in this report.
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TASK 2
Importance of capital structure and optimum capital structure in organisation
To ascertain the requirement of funds for operational activities in an organisation, this
required to have proper records of all transactions. The capital structure of a business
demonstrates the ability and efficiency of firm in meeting the long term as well as short term
financial needs. Therefore, these are the initial needs of the business which will be gathered by
obtaining funds from the external environment or from the operational activities (Muneer and
et.al., 2017). The financial position of an entity will be derived as making payments of
debentures to the investors who has obtained the preferred or equity shares in business.
The importance of Capital Structure:
In order to manage the financial viability of an organisation it will be important for the
business in various terms and aspects such as:
Value maximisation: The properly manages capital structure of firm will be helpful in
having better market value. It determines the aggregate value of claims and capital interest of
equity holders (Blaylock, Gaertner and Shevlin, 2017). Moreover, it can be said that these
transactional activity will be helpful for the entity in terms of creating the brand value in the
market as well as attaining the favourable amount of funds.
Cost minimization: In relation with the appropriate management of the funds it can be said
that there are various costs indulged with the operational activities of the firm. The managed
capital structure will be helpful to the entity in terms of it reduces the cost of finance and costs or
capital of the firm. It includes the determination of the funds requirements as well as utilisation
in each activities and the variance amount will be carried forward to the next period. Moreover
the proper execution of financial statements of the firm will be beneficial in managing the costs
incurred in operational activities (Capital Structure: Concept, Definition and Importance, 2017).
Opportunities for investments: It will be helpful to the firm as the managed capital structure
will periodically disclosed among the investors or external users. Similarly, it will have positive
impacts over the capital level of the firm. Thus, many of the investors will be attracted towards
the firm’s profitability (Dhaene and et.al., 2017). Moreover, it will be beneficial for the owners
to have appropriate amount of capital collection.
Growth of entity: it will be beneficial in terms of wealth maximisation. Moreover the firm
will have appropriate reserves and saving which will enhance the rate of investment. Thus, main
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use of capital structure to allocate the funds for each business operations and make the adequate
investments in various activities (Arrow, 2017). Therefore, the efficiency of the firm will be
increased and which will be helpful or them in terms of meeting the short terms and long term
debts efficiently.
Increase the share value: the managed capital structure improves the financial health of
business which in turn helpful in increasing the share price. Therefore, the firm will have
appropriate earning over each share in the market (Muneer and et.al., 2017). It improves the
share value of ordinary shares therefore which will be attractive to investors in terms of having
the appropriate dividend payments.
TASK 3
Explaining the term rights issues and how company derive theoretical ex-rights price
shares of victory limited 150000000
price earning P/E ratio 20 times
PE ratio Market price per shares
EPS
EPS profit 16000000 0.10667
no. of shares 150000000
PE Ratio 20 MP 2.13333
0.1066667
Price of right issued 2.1333333
15% discount 1.8133333
Theoretical Ex-Right Price new shares*issued price + old shares *
market price
new shares + old shares
no of shares to be issued 15000000*1/5 30000000
new shares*issued price 30000000*1.8133 54399000
old shares * market price 150000000*2.133 319950000
total shares 30000000+15000000
0
180000000
theoretical ex-rights value 2.0797167
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Interpretation: in relation with Financials of Victory Ltd as per the prior rate of right issues
in the market and the old value of shares. Therefore, on the basis of theoretical ex-right value of
shares it has been determined that the firm is providing discounts to issue the shares which will
be beneficial as to have the adequate increment in the share value of the each equity. Moreover,
it will be beneficial for the firm to have the appropriate increment in the profitability as well as
revenue gathering. Thus, to have the appropriate gains more than the profits gathered by the firm
the rate will be beneficial in making the adequate capital gathering. Thus, the capital collection
will be helpful to them in terms of raising the efficiency to meet the dividend requirements of the
firm.
TASK 4
Calculation of price the rights issued would be traded
In relation with the above listed table, it can be said that firm will have profitable gains in
the long run of the business. Moreover, to have the appropriate funds for the operations there will
be need of making the adequate analysis over the market and investors. Thus, in relation with
Victory Ltd. It has been determined that the new shares will be issued by the firm at 15% of
discount rate which will be helpful in making the appropriate rise in the share value. Therefore,
there will be sale of large numbers of shares, which in turn bring the appropriate gains to the
firm. Thus, the price of right issued will be 2.08 which is comparatively fruitful and profitable in
terms of stabilising the capital structure of the firm.
TASK 5
Explaining five methods of raising capital
There are various methods of raising capital, which help organisation to initiate activities
in effective way. Five methods are as follows-
1. Bank loan-
This is one of the most common source of finance for the company. Victory Ltd may
easily expand its operations by taking loan from the bank as it has good solvency position. Loan
from bank requires paying instalments along with interest accrued on the same. This implies that
company has to repay principal amount with interest on it (Titman, Keown and Martin, 2017).
This will provide with funds by which it can easily plan for expansion. Thus, bank loan can be
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taken by the company to have enough of capital at its disposal and as such, it may be able to
extract benefits in the best possible manner.
2. Sale of assets-
Company has number of assets that are required in order to achieve production with
much ease. This help organisation to accomplish more productivity in effective manner.
However, with passage of time some assets become obsolete and no longer helping company in
achieving desired production. Thus, Victory Ltd can sell these fixed assets to fulfil capital
requirements in the best possible way. Thus, sale of assets may provide with necessary funds to
company and as such, it will impart benefits quite effectually. Thus, organisation may sell-off
assets and generate amount for expansion purpose (Phan, Khieu and Golec, 2017).
3. Retained earnings-
Retained earnings is another method of raising capital, which may help company to meet
its objectives in effective manner. This is internal source of finance and is much helpful when
firm earns enough of profits. This method means that out of the profits generated by firm, some
percentage of it is transferred to retained earnings and as such, remaining part of profits are
distributed to shareholders in the form of dividend on their shares subscribed by them. This
implies that company can easily take advantage of profits as a method of raising capital in the
best possible manner. Victory Ltd can take benefit by retaining some part of profits at its end and
impart remaining profits to shareholders and as such, it may generate funds.
4. Share capital-
This is another source of generating funds for the purpose of expansion of the firm.
Victory Ltd can initiate funds by issuing shares and may garner finance in effective manner. This
implies that company may easily take advantage of this method for its expansion in the best
possible way. Issuing share capital to subscribers can provide funds with much ease to
organisation and it can extract benefits out of the same. Moreover, this method is less risky than
debt financing as no interest payments are to be made by the company. Thus, there is no liability
that arises on company by issuing shares (Tuasikal, 2017). Thus, Victory Ltd can avail this
method for expanding its operations.
5. Angel investors-
This is another method of raising finance by Victory Ltd. Angel investors provide funds
to company by having stake in the business. This means that these type of investors take some
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part of ownership in firm and then provide necessary funds to company. This may help firm in
effective way as they provide valuable advice to organisation to initiate healthy operations and
meet set targets with much ease. Thus, angel investors are better option for organisation to
generate funds and expand easily.
TASK 6
Investment appraisal techniques for choosing project
Calculation of NPV
Formula – Total cash flows / Initial investment
Project 1
Year Cash flows
Discounting
factor @ 20%
Discounted Cash
flow
0 300000
1 150000 0.8333333333 125000
2 150000 0.6944444444 104166.666666667
3 50000 0.5787037037 28935.1851851852
258101.851851852
Initial investment 300000
NPV -41898.1481481482
Calculation of IRR
Year Cash flows
0 -300000
1 150000
2 150000
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3 50000
IRR 9.54%
Calculation of Payback period
Formula – Initial investment / Total cash flows
Year Cash flows Cumulative cash flow
0 300000
1 150000 150000
2 150000 300000
3 50000 350000
Total cash flow 350000
Initial investment 300000
Payback period 0.8571428571
Calculation of ARR
Formula – Average annual profit / Average investment
Year Cash flows
0 -300000
1 150000
2 150000
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3 50000
350000
Average annual profit 116666.666666667
ARR 38.89%
Project 2
Year Cash flows
Discounting factor @
20%
Discounted Cash
flow
0
1 150000 0.8333333333 125000
2 150000 0.6944444444 104166.666666667
3 150000 0.5787037037 86805.5555555556
315972.222222222
Initial investment 250000
NPV 65972.2222222223
Calculation of IRR
Year Cash flows
0 -250000
1 150000
2 150000
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3 150000
IRR 36.31%
Calculation of Payback period
Year Cash flows Cumulative cash flow
0 250000
1 150000 150000
2 150000 300000
3 150000 450000
Total cash flow 450000
Initial investment 250000
Payback period 1.8
Calculation of ARR
Year Cash flows
0 -250000
1 150000
2 150000
3 150000
Average annual profit 150000
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ARR 60.00%
Project 3
Year Cash flows
Discounting factor @
20%
Discounted Cash
flow
0
1 100000 0.8333333333 83333.3333333333
2 150000 0.6944444444 104166.666666667
3 200000 0.5787037037 115740.740740741
4 250000 0.4822530864 120563.271604938
423804.012345679
Initial investment 300000
NPV 123804.012345679
Calculation of IRR
Year Cash flows
0 -300000
1 100000
2 150000
3 200000
10

4 250000
IRR 37.30%
Year Cash flows Cumulative cash flow
0
1 100000 100000
2 150000 250000
3 200000 450000
4 250000 700000
Total cash flow 700000
Initial investment 300000
Payback period 2.3333333333
Calculation of IRR
Year Cash flows
0 -300000
1 100000
2 150000
3 200000
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4 250000
Average annual
profit 175000
ARR 58.33%
The project should be evaluated on the basis of capital investment appraisal techniques so
that effective return may be generated by the organisation in the best possible way. In relation to
this, there are various capital investment techniques such as ARR (Average Rate of Return), IRR
(Internal Rate of Return), NPV (Net Present Value) and payback period. Each one of these
techniques are beneficial for organisation in selecting project out of the various available
alternatives. This help to take effective and better decision with regard to project with much ease
(Jankensgård and Vilhelmsson, 2017).
Transparent view Plc has three projects for improving upon its services in the best
possible way. These three projects are evaluated on the basis of investment appraisal techniques
in order to select best option out of alternatives. For overcoming such problem, computation of
investment appraisal methods are arrived at for all the three projects in order to select highest
yielding project having maximum returns to the organisation. Project 1 and Project 2 both lasts
for three years, while, Project 3 lasts for four years.
Starting with project 1 which has initial outlay of RM 300,000 and cost of capital is at the
rate of 20 % and as such, NPV is calculated. The value of NPV is negative as computed above
and is -41898.14. This makes clear that project is not worthwhile to invest in it. The reason
behind rejection of this project is simple as it implies that Transparent view Plc will not be able
to earn adequate returns in the future. It is recommended by market experts that positive NPV
should be there and as such, higher the NPV, organisation should invest in the project (Mayer,
Warr and Zhao, 2017). Furthermore, IRR calculated is 9.54 % which shows that it is very low
and good rate of return will not be generated by company and thus, investment should not be
made. However, payback period is low which means that return will be produced in less time.
On the other hand, ARR is 38.89 % that is also not good as compared to other projects. Thus, it
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can be said that organisation should not invest in Project 1 because it is not profitable to the
company.
Project 2 which lasts for also three years and has initial outlay of RM 250,000 and as
such, all four techniques are applied and results have been arrived at. NPV is calculated for this
project and is 65972.22 that is positive. This implies that organisation will generate positive
returns in the coming year and will be able to improve upon its services (Sweeting, 2017).
However, NPV is good for the project but as compared to Project 3, it is low.
This clarifies that this project though has positive returns is less than NPV of other
project. While, payback period is 1.8 which is more than compared to Project 1 and it implies
that project will take much time to yield adequate returns. ARR is 60 % which is really good as
compared to all projects at firm's disposal. This shows that company will have better annual
returns by investing in it. On the other hand, IRR is good that means that project will generate
good rate of internal returns. But its NPV is less, thus, investment should not be made in it. The
main reason behind relying mainly on NPV is that the technique clarifies profitability of project.
Project 3 which lasts for four years and has initial outlay of RM 300,000. NPV computed
in this option is highest among all other alternatives. This is evident from the fact that it has
123804.01 of NPV that is more and as such, organisation should invest in the same as better
returns will be generated by the project in the coming years in the best possible way.
Furthermore, NPV is the highest which clarifies that organisation should invest as positive
returns will be produced and as such, profitability position will be enhanced as well. Value of
ARR is 58.33 % which is good for the company (Akbas, Boehmer, Erturk and Sorescu, 2017)
and positive returns may be produced by investing in the project. Furthermore, IRR is good as
well and is 37.30 % which clarifies that adequate returns will be generated by the firm in the best
possible way. On the other hand, payback period is 2.33 which means that investment will be
take some time to generate to yield returns. But on the account of NPV, it is good and positive
which means that investment should be made in Project 3.
TASK 7
Factors to be consider before arriving at final decision on a project
There are many factors which are required in selection of project in that way which
provides clarity to organisation before making final decision on a project. This is required
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because capital investment should be made by complying with various factors before taking final
decision on the same. In relation to this, apart from investment appraisal techniques which are
discussed above, non-financial factors are also required to take into account (Ingram, 2018). This
is evident from the fact that though a project may be good as per capital investment techniques
which is based on financial data but may not be worth on the aspect of non-financial data which
is utmost required in the organisation. In simple words, final decision should be made in
accordance to the financial and non-financial data so that project may be evaluated on equal
basis.
The non-financial factors play important role in the company in carrying out correct
decision in the best possible manner. The factors contain are safety of employees and public,
necessity to maintain existing lines of products, entry to new market. Safety of employees is one
of the main non-financial concern of organisation so that it may function well. The workers are
integral part of company and as such, viability of project should be fairly identified so that no
project may be selected which is hazardous to employees. The same apply to society as well and
as such, it is required that values and beliefs of society should be taken in consideration while
selecting project. Another is necessity to maintained existing products line that means that
investments are taken to aid in manufacturing of items and to increase production capacity and as
such, this should be taken in consideration by the company.
Entry to new market is another type of investment which is taken in order to strengthen
organisation's product portfolio and as such, entry is essentially required in the new market to
garner more customers. This will help company to enter in new market and earn more revenue.
Thus, this consideration should also be taken by the firm to select appropriate project in balanced
way. Moreover, there are various other factors required to be considered by the company before
making final decision regarding project (Chen, Lu and Yang, 2017). Among this, ethical
considerations, environmental concerns are main factors driving company before approving the
project in the best possible way.
Ethical considerations include employee safety, societal norms and values, which are
required to be taken into account by the firm. Transparent view Plc is required to assess project
on this behalf so that it may satisfy society as at the end business is started to provide better
goods and services to society and as such it is required by the company to select project by
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taking ethical consideration as a priority before arriving at a decision. The investment may
affects society because of new equipment’s, modern technology installed in the organisation’s
premises and as such, it is needed to take this into account. Overhauling on equipment in order to
increase production may affect society. Thus, company should consider this fact before making
decision to invest in the project.
Furthermore, environmental concerns should also be there because sometimes investment
may be hazardous to nature and as such, organisation should put forward the same. Capital
investment should be made with utmost care by the management so that no harm may be
provided to the nature in any manner (Idris, Krishnan and Azmi, 2017). This is evident from the
fact that investment are made on more financially appealing alternative without thinking over the
nature. This harms environment and as a result, firm should make concern about this fact to
extract results in the best possible manner. Thus these factors are required to be considered by
Transparent view Plc to make final decision about the project.
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CONCLUSION AND RECCOMENDATIONS
Hereby it can be concluded that finance is essentially required in the business for
smoothing operations and accomplishing production in the best possible manner. The company
requires finance in order to meet daily requirements and achieving tasks in effectual way. It can
be concluded that Victory Ltd can expand its operations in the manufacturing sector as it has
good financial position in the market. Furthermore, it can be said that company can issue shares
at discount by adopting theoretical ex-rights price option in effective manner. It is recommended
that company should have balanced capital structure so that it may extract benefits of debt and
equity at its disposal quite effectually. This is required as complete relying on equity may be
riskier for the firm as it inculcates that more dividends are to be paid and on the other hand,
excessive use of debt in the capital structure may hamper solvency position as interest along with
principal amount is to be repaid to creditors. Furthermore, it is recommended that company
should take adequate source of finance as each one has benefits and limitations.
Moreover, Transparent view Plc has three projects on its disposal and best alternative is
to be selected which provide higher returns in effective manner. This will help company to have
investment in better project. It is recommended that organisation should invest in the Project 3 as
it is better option among other alternatives. This is evident from the fact that NPV is much higher
as compared to other projects whereas, IRR, ARR are also good and as such, it is recommended
to invest in this project only. Moreover, capital investment appraisal techniques are quite helpful
in attaining correct decision in the best possible manner. Thus, organisation should invest in the
project as it yields maximum return in effective way. This investment will be beneficial for the
company in accomplishing objectives quite effectually. Furthermore, it can be said that in order
to attain goals, firm is required to have optimum mix of capital structure for extracting benefits
in the best possible way. Thus, it can be said that finance plays crucial role in the company for
meeting its daily requirements of capital and as such, firm should utilise funds in that way which
maximises revenue quite effectually.
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REFERENCES
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Sweeting, P., 2017. Financial enterprise risk management. Cambridge University Press.
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