Financial Management Decisions Making - Desklib

FINANCIAL
MANAGEMENT DECISION
MAKING

Table of Contents
QUESTION 1..................................................................................................................................3
QUESTION 2..................................................................................................................................5
(a).................................................................................................................................................5
(b).................................................................................................................................................5
QUESTION 3..................................................................................................................................7
(a) Calculation of Net Present Value of both Project A and Project B of Zonta Plc...................7
(b) Calculation of Internal Rate of Return (IRR) of Project A....................................................9
(c) Strength and Weakness of Internal Rate of Return Method.................................................10
(d) Ways of incorporating risk into the investment appraisal process.......................................11
QUESTION 4................................................................................................................................12
a. Methods assisting managers in making maximizing and minimizing decisions while dealing
with capacity limitation.............................................................................................................12
b. Calculation of optimal product mix and sales mix with an objective to maximize
profitability................................................................................................................................14
REFERENCES..............................................................................................................................17

QUESTION 1
Financing through equity shares and debt indicates that the company capital structure in
terms equity and debt respectively. Companies always aims for maximizing its value in the
market along with keeping its cost of capital at the lowest and this is can be possible through
having optimal capital structure. Accordingly, optimal capital structure could be ensured by
having appropriate or best mix for equity and debt financing in the capital of the company. A
well - known financial management theory with respect to the determination of optimal capital
structure that could minimize the weighted average cost of capital of the company is M&M or
Modigliani – Miller theory (Arribas, Tortosa-Ausina and Zhu, 2021). According to this theory,
while operating in perfect markets, it doesn’t matter what capital structure the company is using
because the market value of the company is determined by its power to generate earnings and the
risk associated with the concern’s underlying assets. It is believed that the market value of the
company is independent of the method of financing that the company is using. There are two
propositions given under this theory, such as the following:
Proposition I: There is no relationship between capital structure and company’s market value
and accordingly, the value of two firms that are identical to each other would remain the same
and there is no impact of the choice of financing over its valuation (Brusov, Filatova and
Orekhova, 2022). However, the value of firm is dependent over its expected earnings in the
future which is discounted through WACC. At this point, firm realizes to reduces its WACC
because there lies inverse relationship between WACC and the value of the firm where a higher
WACC leads to lower valuation of the company while a lower WACC leads to greater valuation
of the company. So, if there is an optimal capital structure where appropriate mix of debt and
equity is there in the capital of the company which has been determined on the basis of cost
associated with equity and debt component, it leads to minimum WACC or cost of capital for the
company. Accordingly, the company enjoys greater valuation in the market (Dakua, 2019).
Proposition II: This proposition is based on financial leverage which means use of borrowed
capital or debt proportion in the overall capital structure of the company which leads to
maximization of return on investment. This in turn boosts the valuation of the company along
with reducing its Weighted Average Cost of Capital.

Also, as per the theory based on Net Income Approach, it is believed that company’s
value can be increased with the reduction in the overall cost of capital or WACC. It is possible
for the firm to reduce its WACC by including greater proportion of debt rather equity in the
overall capital structure of the company as the former is considered to be cheaper than the
former. Debt reduces the WACC as Weighted Average Cost of Capital is determined through
multiplying cost of debt and cost of equity with the weights of equity and debt components
respectively in the overall capital structure of the company. Therefore, as per the net income
approach, it has been stated that a change in company’s financial leverage leads to a change in
the weighted average cost of capital which in turn changes the valuation of the company
(Rahman, Sarker and Uddin, 2019).