(Solved) Financial Management Assignment with Answers

Financial Management

Table of Contents
INTRODUCTION...........................................................................................................................4
Question 2: ......................................................................................................................................4
(a) Right issue concept:................................................................................................................4
(b) Scrip dividends and its advantages: ......................................................................................6
Question 3: ......................................................................................................................................7
(a) Determination of economic feasibility of project by using various investment appraisal
techniques: .................................................................................................................................7
(b) Evaluation of benefits and limitations of different investment techniques:.........................11
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................14

INTRODUCTION
Financial management means planning, organising, directing and controlling the financial
activities which includes raising of funds (finance) and utilising the funds of enterprises. It have
main aim to is calculating ratio analysis, equities and debts related aspects. Financial
management helps the the company in reducing its cost of raising finance and ensure sufficient
availability of finance. A company can raise funds for its business operations In this report,
different appraisal techniques are explained to understand the various capital budgeting decision
very well along with there benefits and limitations ( Nelson and Murray, 2012). This report
provides information about equity finance and right issues by solving a practical problem.
Various investment appraisal techniques are explained in detail by solving a practical problem.
Question 2:
(a) Right issue concept:
Right issue is an option given to the existing shareholders to purchase the additional new
equity shares in the company, this is known as right given to the existing shareholders and these
additional shares are known as right shares. There are various benefits of issuing right shares that
are as follows:
 The main benefits of this to the shareholders is that shares are issued at discount price to
encourage them to purchase the rights issue.
 Company can save significant amount of money by issuing such right shares such as
underwriting commission, advertisements cost and other related cost.
 By issuing these types of shares, company make equitable distribution of shares along
with same proportion of voting rights.
These rights may have some types that may be understood as follows:
 Renounce-able Rights Issue: In this types of issue of right shares, the existing
shareholders have right to transfer their rights to any other person even if to a person that
is not company's shareholder (YI, 2016).
 Renounce-able Rights Issue: in this type, the existing shareholders has not right to
transfer their rights to anyone.
Some limitations of right issue:

 In this method, company may not able to raise more funds and not able to achieve its
target.
 The value of each shares may get diluted if there are increased number of share issued.
 It right issue is issued by the well known company, then it has give a wrong impression in
the market that company has not sufficient money and it is struggling to run its business
activities smoothly (Graves and Ringuest, 2012).
This concept can be understood by solving the practical problem which is as follows:
Information given in the question:
Profit after tax (PAT) = 20 percent of share holders funds
ordinary shares of 50p each = 300000 (i.e. 6000 shares of 50 pound each)
Reserves = 400000
700000
Amount which is required through right issue = £180000
current ex-dividend market price of Lexbel plc = £ 1.90
Different rights issues prices suggested by the management = £1.80, £1.60 and £1.40
(i) Calculation of number of shares:
 For right issue price £ 1.80: 180000/ 1.80 = 100000 shares
 For right issue price £ 1.60: 180000/1.60 = 112500 shares
 For right issue price £ 1.40: 180000/1.40 = 128572 shares
(ii) Calculation of theoretical ex-rights price:
 For right issue price £ 1.80: {(6000*1.9) + 180000} / 106000 = £ 1.81 (Answer)
 For right issue price £ 1.60: {(6000*1.9) + 180000} / 118500 = £ 1.62 (Answer)
 For right issue price £ 1.40: {(6000*1.9) + 180000} / 134572 = £ 1.42 (Answer)
Note: Formula for theoretical ex-right price = ( market value of shares prior to right issue +
cash raised from right issue) / Number of shares after rights issue
(iii) Expected earning per share:
 For right issue price £ 1.80: 140000/106000 = £ 1.32
 For right issue price £ 1.60: 140000/ 118500 = £ 1.18
 For right issue price £ 1.40: 140000/ 134572 = £ 1.04
(iv) Tabular presentation of above calculated results and evaluation of best option:
Particulars For right issue For right issue For right issue

price £1.80 price £1.6 price £1.4
Number of shares to be issued 100000 shares 112500 shares 128572 shares
Theoretical ex right price per share £1.81 £1.62 £1.42
Expected earning per share £1.32 £1.18 £1.04
Recommendation:
From the above results related to right issue by the company, it may said that option one
is the best proposal (i.e. right issue price £1.80) because in this option, company has high ex
right price per share and also shareholders earn more per share (£ 1.32)as compared to other two
options. Therefore, company has to consider the suggestion of doing £1.80 right issues price as
provide by the finance director.
(b) Scrip dividends and its advantages:
Scrip dividends is an incentive given to the shareholders of the company for giving cash
dividend in some future point in time. In this, when an organisation gives scrip dividends, it
means that they provide the shareholders, the increment in their holding size without incurring
any fees (Genest, Gendron and Bourdeau-Brien, 2013). This is an option with the company to
give scrip dividend in the lieu of cash, if company has not sufficient money now to pay its cash
dividend. The various advantages of scrip dividends are as follows:
From the point of view of shareholders:
 The main advantages of such method of payment of dividend is that this helps the
shareholders in painlessly increase their shareholding in the company without payment of
commission amount (brokerage) and stamp duty.
 If there is circumstances, where company's shares value is under-priced, in such
circumstances, shareholders would like to accept the scrip dividend.
 Investors by accepting scrip dividend can take tax advantages because in this dividend
are in the form of shares.
 A share issued under scrip dividend may decrease the company's gearing and it may helps
the company in enhancing its borrowing capacity (Purce, 2014).

From the point of view of company:
 The main advantages of scrip dividend is that company does not need to spend its cash to
pay such dividend and in certain circumstances it helps the company in tax saving.
 It helps the company in saving of cash for diversification of its business operations and
for reinvestment purposes (Power, 2012).
There also some disadvantages in scrip dividends which are as follows:
 In case of dividend per share is maintained or increased then total cash paid shall
increased.
 It may be seen as a negative signal by the market that company has not enough money to
pay its dividend and it suffers some cash flow Mazanai, M. and Fatoki, O., 2012Ayoub,
S., 2014YI, X.H. and ZHOU, Z.F., 2012Hofmann, E. and Johnson, M., 2016problems.
 It may not be beneficial for the shareholders to accept scrip dividend in lieu of cash
dividend in case, where shareholders requires cash and the main income source of such
shareholders is only cash dividend.
 Scrip dividend is also not suitable for the company where it does not want to issue
additional shares and does not want to increase its share capital but due to cash flow
issue, it has to pay scrip dividend (Fayol, 2016).
Question 3:
(a) Determination of economic feasibility of project by using various investment appraisal
techniques:
In an business organisation, there are various proposed projects are come in front of the
company, it shall need to evaluate these projects to choose best one by using several investment
techniques. The detailed discussion of these investment appraisal are as follows by solving a
practical question:
(i) Payback period:
This method help the company in finding the total time period up-to which it can
recovered its money which is invested at the starting point of project. In other words, it may be
said that this method is used by the company to finding the break event period of project (Ayoub,
2014). This method does not consider the net cash inflows that a company earned after its pay
back period (break even period).

Calculation of Payback Period for Happy Meal Limited:
Particulars Amount(£)
Starting or Initial Investment 320000
Particulars Y 1 Y 2 Y 3 Y 4 Y 5 Y 6
Annual Cash Inflows ( as given) 105000 105000 105000 105000 105000 105000
Less: Annual Cash Outflows ( As
given)
15500 15500 15500 15500 15500 15500
Net annual Cash Inflows 89500 89500 89500 89500 89500 89500
Total payback period (years) 3.58
Recommendations:
After considering the above calculations related to pay back period, it is clearly evident
that payback period is 3.58 years. This means that its payback period is less than total project
period.
Therefore, it can be said that, it is a viable project and need to investment in it.
(ii) Accounting rate of return:
It is an appraisal method in which accounting rate of return is calculated for the given
project by dividing the average net profit from average investment. It is a method for measuring
the expected profitability from any capital investment (Rahaman and Al Zaman, 2013).
Computation of Accounting rate of return for Happy Meal Limited
Particulars Amoun
t
Starting or Initial Investment as
given
320000
Particulars Y 1 Y 2 Y 3 Y 4 Y 5 Y 6

Annual Cash Inflows (As given) 105000 105000 105000 105000 105000 105000
Less: Annual Cash Outflows 15500 15500 15500 15500 15500 15500
Net annual Cash Inflows 89500 89500 89500 89500 89500 89500
Less: Depreciation @ 20% 57600 46080 36864 29491.
20
23592.
96
18874.3
7
Net annual Cash Inflows after
providing depreciation
31900 43420 52636 60008.
80
65907.
04
70625.6
3
Average net accounting profit
(Net annual Cash inflows –
Average amount of
Depreciation)
54082.9
1
Initial Investment (as given) 320000
Accounting Rate of return 16.90 %
Accounting Rate of Return is computed by dividing Average Accounting Profit by Initial
Investment in respect of Happy Meal.
Working Notes:
Computation of depreciation on new machine purchased by Happy Meal Limited:
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Cost of new machine 320000 230400 184320 147456 117964.
80
94371.8
4
Less: Amount of salvage Value
@ 10% (as given)
32000 0 0 0 0 0
Net cost of new machine 288000 230400 184320 147456 117964.
80
94371.8
4
Less: Depreciation @ 20% (as
given)
57600 46080 36864 29491.
2
23592.9
6
18874.3
7
C/f balance as cost of machinery 230400 184320 147456 117964
.8
94371.8
4
75497.4
7
Average Depreciation of new
machinery
35417.0
9

Recommendation:
From the above calculations related to accounting rate of return, it is clearly evident that
the accounting rate of return (16.9 %) is high from its cost of capital (12%).
Therefore, such investment proposal is viable and company should invest into such
project.
(iii) Net present value:
NPV is a technique to determine any investment proposal, in this method, company need
to calculated the present value of its future net cash inflows flow and present value (P.V.) of its
net cash outflows without the help of discounting factor (Mazanai and Fatoki, 2012). There after,
P.V. Of net cash outflows are calculated from the P. V. of net cash inflows to find the net present
value of given project (Caselli and Gatti, 2017).
Cash inflow PV factor @ 12% Disc. Cash Flow
89500 0.892 79834
89500 0.797 71331.5
89500 0.711 63634.5
89500 0.635 56832.5
89500 0.567 50746.5
89500 0.506 45287
32000 0.506 16192
Discounted Cash Flow 383858
Less - Initial investment 320000
Net Present Value 63858
Note: At the end of 6th year, company has recovered the residual value from its new machine, due
to this, it has to be included in net cash inflows from 6th year and thereafter, it shall required to
calculate present value of cash inflows from such year.
Recommendations:
After considering the above calculation related to NPV, it is clearly stated that NPV is
63858 which is positive. Therefore, company should investment in this project.
Internal rate of return:

It is a discount rate which is hidden inside the project that makes the net present value of
a project zero. In other words, it is an expected compound annual rate of return for earning from
a proposed project.
Particulars
Initial investment 320000
Discount Rate : Lower (a) 12.00%
Discount Rate : Higher (b) 18.00%*
NPV @ 12% discount rate 47666
NPV @ 18% discount rate -41439.31
Difference in discount rates [(B)-(A)] 6.00%
Internal Rate of Return3 15.21%
Working Notes:
Computation of NPV and Discounted Cash Flows under IRR if discount rate is 12%:
Annual Cash
inflow
Present value factor @ 12% Annual Discounted
Cash Flows
89500 0.89 79834.00
89500 0.80 71331.50
89500 0.71 63634.50
89500 0.64 56832.50
89500 0.57 50746.50
89500 0.51 45287.00
Discounted Cash Flows 367666
less:- Initial investment (given) 320000
Net Present Value (a) 47666
Computation of Discounted Cash Flows and NPV under IRR when discount rate is 18%:
Cash inflow PV factor at 18% Disc. Cash Flows

89500 0.85 75847.46
89500 0.72 64277.51
89500 0.61 54472.46
89500 0.52 46163.10
89500 0.05 4736.53
89500 0.37 33153.62
Discounted Cash Flows 278650.69
Less:- Initial investment (given) 320000
Net Present Value (b) -41349.31
Recommendation:
From the above calculation related to internal rate of return, it is clearly stated that IRR is
15.21% greater than its cost of capital which is 12%. therefore, in IRR point of view, the
proposed project is viable and company should accept this project.
(b) Evaluation of benefits and limitations of different investment techniques:
A company may use different – different investments appraisal techniques for its various
investment projects. But before considering these techniques, company shall required to evaluate
the various benefits and limitations which are comes with these appraisal techniques (Kelly,
2012).
Payback period:
 Benefits: The main advantages of this technique is to use of time value of money. It helps
the company in determining the actual risk involved in a project.
 Limitations: The main disadvantages of using this technique is that it does not assist the
company in taking decision whether it increase the value or not. Calculations of payback
period gets confused if there are multiple negative cash flows.
Accounting rate of return:
 Benefits: It is easy to calculate the ARR and all the needed information is easily available
with the company.
 Limitations: It is not a right rate of return because company ignores time value of money
and it uses the arbitrary benchmark cut-off rate. It is based on book value and net income
and not considered the cash flows and market values.

Net present value:
 Benefits: It is based on reinvestment assumptions and considers the conventional cash
flow pattern with the help of all the cash flows. The main benefit of this technique is to
have good measure of profitability and considers the factors risks. The important benefits
of using this technique is that it consider the time value of money.
 Limitations: It is not so good as it is considers the estimated rate of opportunity cost
rather than actual rate. The main disadvantages of using this technique is that it ignore the
sunk cost and in this method, company face the problem of determining the required rate
of return. It not helpful in boosting the EPS and ROE of the company and also not
suitable in case of different size of projects (Lapavitsas, 2013).
Internal rate of return:
 Benefits: The foremost benefits of using this technique is that it consider the time value
of money while calculating IRR and it is very simple to interpret by the company as well
as by all key stakeholders. In this technique, manager may make rough estimate of
required rate of return.
 Limitations: In this technique, economies of scale is ignored and there is impractical
implicit assumption of reinvestment rate at IRR. Due to using this technique, dependent
or contingent project are being ignored while calculating IRR and it ignores mutually
exclusive projects. Increase in wealth is not possible to be measured by IRR under this
method (Ruan, 2019).
CONCLUSION
From the above report it is concluded that for evaluating any investment proposals by the
company, it shall require to consider the various investment appraisal techniques after
considering the various benefits and limitations as associated with these techniques. It is further
concluded that an company shall evaluate its decision to raise money from issuing new shares to
outsiders or to existing shareholders. Right issue of shares may help the company in raising
additional funds without having interruption of outsiders. Company shall also consider the
concept of scrip dividend in case of insufficient cash amount. It is further concluded that net
present value method is most beneficial techniques because it has less limitations and has
immense advantages to the company in selecting best investment proposal.

REFERENCES
Books and Journal:
Lee, W.F., Boehlje, M.D., Nelson, A.G. and Murray, W.G., 1980. Agricultural finance (No. Ed.
7). Iowa State University Press..
Graves, S.B. and Ringuest, J.L., 2012. Models & methods for project selection: concepts from
management science, finance and information technology (Vol. 58). Springer Science &
Business Media.