Financial Management: Cost of Capital, Capital Structure, Investment Appraisal Techniques

This article covers topics related to financial management such as cost of capital, capital structure, and investment appraisal techniques. It explains the assessment of overall WACC cost of capital and the link between IRR and WACC classification. The article also provides insights into accounting rate of return and its calculation.

Management

Contents
Contents...........................................................................................................................................2
INTRODUCTION...........................................................................................................................1
MAIN BODY..................................................................................................................................1
Question 1- Cost of Capital and Capital Structure......................................................................1
a. Cost of equity...........................................................................................................................1
WACC with Book value and Market Value................................................................................3
b. Assessment of Overall WACC Cost of Capital.......................................................................4
c. Interpretations..........................................................................................................................7
d. There is a link between the company's IRR and WACC classification...................................8
Question 2- Investment Appraisal Techniques............................................................................8
Accounting Rate of Return..........................................................................................................9
b. Organizational Effects of Investment Appraisal Techniques................................................11
c. Benefits and Disadvantages of Capital Assessment Technique in the Sector.......................13
CONCLUSION..............................................................................................................................14
REFERENCES..............................................................................................................................15

INTRODUCTION
Financial management is the branch of business that focuses on costs, earnings, funds, and
debts (Alawattage and Wickramasinghe, 2018). Financial management is a management function
wherein the director is in charge of conceptualization, implementation, coordination, regulation,
and evaluation. In ability to execute a business company efficiently, the management must have
a thorough knowledge of fiscal management. Financial authorities have involved incorporating
management strategies into the company's investment tools as well as playing a key role in
budgeting control.
MAIN BODY
Question 1- Cost of Capital and Capital Structure
a. Cost of equity
Cost of equity:
We know,
Given, = Cost of Equity
D1= Most Recent Dividend= 0.28*(1+0.06)= 0.30
Po= Market Value per share= 2.65
F= flotation cost = 0
G= Growth Rate of dividend
0.21 =0.28
0r,
Or, g= 0.0587 or 6%
So,

We know,
=
= 0.1731
=17.32%
Cost of retained earnings:
We know,
Given,
Kr = cost f retained earnings.
D1= Most Recent Dividend= 0.28*(1+0.06)= 0.30
Po= Market Value per share= 2.65
G= Growth Rate of dividend=0.06
So,
We know,
=
= 0.1731
=17.32%
The assessment in both portions remains the identical because the cost of equity and the cost
of retained earnings do not comprise a flotation cost. As Faith Plc. does not have any flotation
charges (Amnuai, 2019).
Cost of preferred share:

We know,
Given, cost of preferred share
D1= dividend after the current year
= face value of preferred share and rate of preferred share
=1*0.07
=0.07
Po= Market Value of preferred share= 75p
So,
We know,
=
= 0.093 or 9.33%
Cost of irredeemable bond:
We know,
Given,
Kb= cost of irredeemable bond
I= interest
= face value of the bond* interest rate
=15000000*0.10
=1500000
T= 0.30
NP= 107*1500000
=16050000

We know,
=
=0.0654
=6.54%
WACC with Book value and Market Value
WACC= (Cost of equity*weight of equity)+ (Cost of retained earnings*weight of retained
earnings)+(Cost of preferred Share* Weight of preferred share)+(Cost of bond* Weight of
bond)
The market value of the share and retained earnings
Market value of equity=2.65*20,000= 53,000
Market value of share capital=
= 42,400
Market value of retained earnings=
=10600
WACC with the market value
Particulars Market
Value
Weight
of
market
value
Cost WACC in Market value
share capital 42400000 0.56 0.1732 0.096992
Retained earnings 10600000 0.14 0.1732 0.024248
Preference share 7500000 0.1 0.0933 0.00933
irredeemable bond 16050000 0.2 0.0654 0.01308

Total 76550000 1 0.14365
WACC in Market value = 14.365%
WACC with a book value
Particulars (A) Book
Value (B)
Weight
©
Cost (D) WACC in Book Value (C*D)
share capital 20000000 0.4 0.1732 0.06928
Retained earnings 5000000 0.1 0.1732 0.01732
Preference share 10000000 0.2 0.0933 0.01866
irredeemable bond 15000000 0.3 0.0654 0.01962
Total 50000000 1 0.12488
WACC in book value =12.488%
The accompanying provides accurate information on Faith Plc's WACC ratio based on the
firm's current marketplace value. The company's total investment efficiency is reasonable, with a
fair ratio of share pricing and a reasonable percentage of borrowing cost (Arnold and Artz,
2019). The average industry evaluation is used to calculate the firm's WACC. Businesses are
having issues in their continued activities, according to the WACC figure established by the
company. In necessary for the firm to remain competitive and sustainable in the near future, it
will be good to raise its investment activity and related share value.
b. Assessment of Overall WACC Cost of Capital
Cost of equity
Given, D1= 0.28(1+0.2)= 0.34
Po= 2.85
G= 0.20
We know,
=
=31.93%

Cost of retained earnings: Without flotation cost the cost of retained earnings= cost of equity
capital.
Cost of preference share:
Given, cost of preferred share
D1= dividend after the current year
= face value of preferred share and rate of preferred share
=1*0.07
=0.07
Po= Market Value of preferred share= 75p
So,
We know,
=
=10.29%
Cost of redeemable bond
We know,
Here, I= interest
=face value of bond* interest rate
=15000000*0.11
=1650000
T=0.30
Net proceed= 100*150000
=15000000
RV=Redemption Value=105*150000

=15760000
N=7 years
We know,
=
=
= 28.73%
WACC with Book Value
New Share Capital= 20,000,000-(15000000/2.65)= 14339622
Particulars Book Value Weight Cost WACC of Book
Value
share capital 14339622 0.24 0.3193 0.076632
Retained earnings 5000000 0.08 0.3193 0.025544
Preference share 10000000 0.17 0.1029 0.017493
irredeemable bond 15000000 0.25 0.0654 0.01635
Redeemable bond 15000000 0.25 0.2873 0.071825
Total 59339622 1 0.207844
WACC with book value 20.7844%
WACC with Market Value
Market Value of Share Capital=
=30302070

Market value of Retained Earnings=
=10565854
Particulars Market Value Weight Cost WACC of
Market Value
share capital 30302070 0.38 0.3193 0.121334
Retained earnings 10565854 0.13 0.3193 0.041509
Preference share 6800000 0.09 0.1029 0.009261
irredeemable bond 16050000 0.2 0.0654 0.01308
Redeemable bond 15750000 0.2 0.2873 0.05746
Total 79467924 1 0.242644
WACC with a market value of 24.2644%
The company's financial significance is given more emphasis in the financial estimates
depending on the realistic analysis produced for Faith PLC. The fundamental factor has to do
with the company's borrowing value and also the pricing structure of its company units. The
value associated with financing is believed to be lower costly, particularly when contrasted to the
business Faith Plc's numerous investment expenditures (Bolino, Long and Turnley, 2016). The
firm’s lending activities might simply be increased by speeding up the sum of interest and
repayments associated with existing debts. It does, however, include measures aimed at reducing
and decreasing the company's evaluated earnings. The reduction in applicable tax liability is
displayed as retained profits. Moreover, earnings protection is widely regarded as among the
most important aspects of the sector for firms. This will be a critical component of the firm's
operational flow administration and also enhancing the corporation's total monetary value.
c. Interpretations
The WACC value on the company's yield on money processes, according to calculations,
is perhaps the most important area for growing the company's funding processes. In addition, the
aspect of executing activities in a structured manner needs the company's commitment to specific
procedures in attempt to implement the similar. Additionally, if the entities oriented prospective
clients, the firm's fundamental investment value will be significantly impacted. It will be a useful
resource to the company in respect of monetary fluctuation assessment and mitigation.

Conventional theory is perhaps the most suitable notion to include in the company's WACC
pricing evaluation technique (Brierley, 2017). The investment activities of Faith Plc, including
its leverage proportion, must be managed in an organised way. This must help to achieve better
and more consistent maintenance of the WACC threshold. When the organization's gearing
proportion rises, on either hand, the WACC value of the company is controlled and protected.
The WACC statistic gets substantially more accurate and trustworthy as the borrowing prices
tied to the firm's investment expenditure climb. A decrease in the effective borrowing rates, on
either side, would assist the organisation in regards of building a more equitable technique of
forecasting for the current and future.
d. There is a link between the company's IRR and WACC classification
In the case of capital management or numerous financial situations of the business, both
the methods, WACC and IRR, are utilised simultaneously, although for different goals.
Moreover, regardless of the notion that they will be used in the identical manner, the concepts of
IRR and WACC differ. It's most well acknowledged as a matrix that shows statistics to calculate
the overall present value of cash inflow sequencing. Likewise, Faith Plc, the present corporation,
uses the approach in reality to determine and analyse network upgrades. The company may
expect more monetary productivity if it set greater corporate goals. Additionally, WACC is a
proportional way of calculating the yearly taxes expenditure of a company's capital assets. It
allows the company to evaluate its payout in particular to determine the value of its corporate
stock structure (Donnez and Dolmans, 2016). While a company starts a venture, it must calculate
WACC to assess the variability of the company, whereas IRR is utilised to evaluate the
spending. The corporation substantially encourages the concept as well as the method of
financial forecasting in order to make a decision on corporate financial exchanges. As a
consequence, such techniques help the company increase its range by selecting promising and
beneficial regions. From a management standpoint, firms used to link the process for making
investment decisions with average financing costs. The link implies that the present value of the
business is more than the value of cash spending, enabling the NPV to be computed, and the
value of NPV is 0.
Question 2- Investment Appraisal Techniques
Given,
Initial Investment= £588,300

Cash Inflow= £223,600
We know,
PBP=
=
= 2.51 years.
Therefore, Pizza Mat (PM) Limited, a fast-food company, would recoup their upfront
outlay in 2.51 years.
Accounting Rate of Return
Given,
Initial investment= £588,300
Cash Inflow= £223,600
Cash Outflow= £32,700
Depreciation= 25%, reducing method
Years= 6
We know,
ARR=
Calculation of Depreciation
Year Beginning Value Depreciation Closing Book Value
0 588,300 588,300
1 588,300 147075 441,225
2 441,225 110306.3 330,919
3 330918.8 82729.69 248189.1
4 248189.1 62047.27 186141.8
5 186141.8 46535.45 139,606

6 139606.3 34901.59 104,705
483595.2
Calculation of Average Profit
Year Cash Inflow Cash Outflow Depreciation Total profit/Loss
1 223,600 32,700 147075 43,825
2 223,600 32,700 110306.3 80,594
3 223,600 32,700 82729.69 108,170
4 223,600 32,700 62047.27 128,853
5 223,600 32,700 46535.45 144,365
6 223,600 32,700 34901.59 155,998
Total Profit 661,805
Average Profit 110,301
ARR=
=
= 18.75%
As a result, Pizza Mat (PM) would see an 18.75 percent yield on their capital.
NPV= – (Initial Investment- Residual Value)
Calculation of Total Present Value of Net Flow
Year Cash
Inflow
Cash
Outflow
Net Cash
Flow
Annuity Factor
1 223,600 32,700 190,900 1.1000 0.909091 173545.5
2 223,600 32,700 190,900 1.2100 0.826446 157768.6
3 223,600 32,700 190,900 1.3310 0.751315 143426
4 223,600 32,700 190,900 1.4641 0.683013 130387.3

5 223,600 32,700 190,900 1.6105 0.620921 118533.9
6 223,600 32,700 190,900 1.7716 0.564474 107758.1
Total Present Value of Cash Flow 831,419
NPV= – (Initial Investment- Residual Value)
= 831,419-(588,300-588,300*0.15)
= 831,419- 5,00,055
=3,31,364
IRR=LDR+
NPV= – (Initial Investment- Residual Value)
Year Net Cash
Flow
Annuity factor Pv of cash
flow
1 190900 1.24 0.806452 153951.613
2 190900 1.5376 0.650364 86218.4212
3 190900 1.906624 0.524487 57942.4874
4 190900 2.364214 0.422974 38939.8437
5 190900 3.051758 0.32768 25139.0947
6 190900 3.635215 0.275087 17587.3562
Total Present Value of Cash Flow 379778.816
NPV= – (Initial Investment- Residual Value)
=379778.816-(588,300-588,300*0.15)
= 379778.816-5,00,055
=(120276.184)

IRR=LDR+
=0.10+ (0.24-0.10)
=0.10+(0.7336*0.14)
=20.27%
As already stated, the above depicts the actual ROI value linked with the company Pizza
Mat (PM) Ltd, as assessed by the analysis (Homburg, Jozić and Kuehnl, 2017). Moreover, the
assessment is made using a three-year process of evaluating whole business performance. Apart
from that, the company's WACC value, depending on estimations provided over the first two
years, indicates a strong business approach. All through this instance, the value of WACC linked
to ROI is estimated to be £0.10 for a 2 year time. On either hand, the corporation's operational
performance has increased during the 3rd year as a result of increased industry fluctuations,
which have increased the corporation's investment valuation. As a result, by reducing the value
of WACC, the instant impact on the company's tax levels has increased. The genuine chance of
Pizza Mat (PM) being limited is predicted to be around 0.11 percentage.
b. Organizational Effects of Investment Appraisal Techniques
New NPV value of Pizza Mat (PM) Limited
Onetime payment of the business -£ 2,23,700.00
Discounting Rate £ 0.12
Annual Income of the company £
1,25,000.00
Variable Cost -£
75,000.00
Overheads rate -£
1,23,600.00
Resale value
Net Cash flow -£ 2,23,700.00 -£
73,600.00
Discounted Cash flow -£ 2,23,700.00 -£
66,240.00

Cumulative value -£ 2,23,700.00 -£
2,89,940.00
NPV -£ 2,89,940.00
According to the current operating evaluation of the company Pizza Mat (PM) Ltd, the
majority of the main evaluation for the company is achieved through the adoption of certain
investment evaluation methodologies. Moreover, the income fluctuation is associated with the
global activities associated with the firm's NPV. As a result, for Pizza Mat (PM) Plc, it is decided
for the goal of determining and measuring integrated favourably and adversely operating
capacity processes (Li and Xia, 2020). In comparison to its actual investment activities, the
company's NPV in the industry would be reduced, according to socioeconomic estimates. It
means that, in addition to remain competitive and long-term sustainable in the industry, the
organisation must prioritise present earnings. Owing to its limited return possibilities, Pizza Mat
(PM) has witnessed a significant increase in industry effect. Additionally, whenever it refers to
offering exact predictions for the similar, the organisation prioritises focused on two key
industries.
The initial segment discusses the firm's fundamental investment prospects. The following
part contains the company's overall income creation predictions for both current and future
perspectives. The evaluation of the similar will give the company with a precise way of
evaluation based on the element of continuous growth. The constrained yield pricing indicates a
positive approach for Pizza Mat (PM) after predicting a three-year efficiency evaluation (North
and Kumta, 2018). The most successful and practical capital investing process that improves a
firm's capability to remain competitive in the industry is an inherent level of profit. It can also be
reached through a technique that provides an accurate assessment of the company's earnings flow
capability in the sector. On the other hand, while analysing and evaluating the overall
organization's feasibility, a considerable emphasis is focused on the firm’s capital expenditure.
Regardless of the reality that perhaps the share value of Pizza Mat (PM) Ltd is dropping, the
company must strive to improve its level of interest and discounted levels in a need to remain
competitive in the near future. The ROI or the company's true yields of profit, is not estimated or
calculated in financial measures. Consequently, the realistic strategy for the similar is developed
by analysing the company's current and past annual investment activities.

On either side, Pizza Mat (PM) limited the evaluation for the company and assessed it
accordingly. For the first two years, the company's ROI had a constant effect on the industry, as
per the data. On the other hand, the cost grew in the next year, which had a substantial impact on
Pizza Mat (PM) Limited's WACC activities. As a consequence of the suggestions made, it can be
stated that Pizza Mat (PM) Ltd must make developing a better means of management over its
WACC degree a prime importance in addition to have a sustainable growth and development its
current and prospective comparative advantage in the industry (Pollitt, Birchall and Putman,
2016).
c. Benefits and Disadvantages of Capital Assessment Technique in the Sector
Investment assessment creates progressive management procedures for companies and acts
as an advocate in financial investing so as to make relevant decisions which can help the firm in
the near future. Generally, the equipment is extremely fast and well-liked for its many features
and benefits. As a consequence, Pizza Mat (PM) has adopted and implemented the
aforementioned in terms of enhancing its financial activities and relationships. In an attempt to
optimise management and execution, the firm could require to assess the advantages and cons of
a specific technique on either end of the spectrum. The resource spending technique and
approach should be split into three areas before starting: payback, return on investment, and
working capital operations. The benefits and limits of investment assessment approaches are as
follows:
Advantages-
 It may assume that the computing technique is straightforward to understand and
compute (Vlotman, Smedema and Rycroft, 2020).
 The company can relate and analyse its prospective budgetary development by
computing operational income.
 The tactics have been taken by multinational companies and many others to enhance the
openness and clarity of their financial management.
Disadvantage-
 Regardless of the reality that the mathematical computation and decision-making
procedures are straightforward, a person's motivations may shift.
 During the computing process, it often gets muddled and seems difficult to understand.

 In considerations of spending allocation, the calculation approach is influenced by a
number of factors (Yu, Yang and Li, 2018).
CONCLUSION
It may be stated that there are many aspects of a company that seem to be extremely
important and significant, and that these aspects must be thoroughly examined and reviewed in
order to bring worth to the company in the extended term. Besides that, it could be inferred that
there are several strategies assessed previously that have a great deal of potential, therefore a
company's comprehensive proficiency in all of them is required in order for a business to
improve its total worth in the sector.

REFERENCES
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