Financial Management Methods PDF

Financial Management

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
QUESTION 2...................................................................................................................................3
(b).................................................................................................................................................3
1) Number of shares & Theoretical ex-right price ......................................................................3
3) Expected earnings per share....................................................................................................3
4) Forms of issue for each of the right issue price ......................................................................3
C) Definition and advantages of scrip dividend from the point of view of company and
shareholders.................................................................................................................................5
QUESTION 3...................................................................................................................................7
(a) Calculation of Investment Appraisal techniques whether to go investing in the project or
not................................................................................................................................................7
B) Critical evaluation of benefits and limitations of different investment appraisal techniques
...................................................................................................................................................10
CONCLUSION..............................................................................................................................14
REFERENCES..............................................................................................................................15

INTRODUCTION
Financial management is set of numerous guidelines, rules and regulations regarding
financial ratios, debts and equities of the company. This system can be adopted by those firms
that needs to have their focus on management and take decisions regarding of distribution of
dividends, retained earnings, amount of capital top be raised, etc. In simple words, it can be said
that the financial management is nothing but a system that has been developed for helping
companies in having a better analysis and management of the capital and taking more profitable
decisions regarding making investments of excessive of money held by the business.
The present study shows a brief description regarding various methods that can be used in
investment appraisal techniques for taking the best decision regarding making investment of
excessive of capital held by firm. Along with brief information it also shows a calculation that
helps choosing the best investment option for gaining maximum amount of profit. In addition, it
also shows calculation and descriptive part relating to capital structure required for taking best
capital investment decision.
QUESTION 2
(b)
1) Number of shares & Theoretical ex-right price
EX-right price refers to the market price that the stock theoretically has the new right issue (kob
and Whitby, 2017). It is used by the company in order to offer more shares to the shareholders at the
discounted price.
3) Expected earnings per share
Earning per share is been computed by dividing the profits of the company with that of the
outstanding shares (Price and Williams, 2018). The resultant outcome reflect the profitability of an
enterprise. It is common for the organization to report for the earning per share which is been adjusted for
the potential dilution of the shares and the extraordinary items.
4) Forms of issue for each of the right issue price
Right issue refers to the right that is given by the company to its existing shareholders for raising
the additional capital (Mateus, Farinha and Soares, 2017). Right issue price is the price at which the
new shares are been issued is less than the market price that is prevailing in the market. In other words, it
means that the shares are issued at discount rate.

Particulars Amount (£)
Current market value of Brand (6,00,000*1.90) 11,40,000
Funds to be raised through right issue 1,800000
Final market value 13,20,000
Particulars Amount (£)
Earnings before rights issue (700000*0.2) 1,40,000
Earnings from new funds (1,80,000*0.2) 36000
Total earnings after rights issue 1,76,000
Particulars Right issue price at 1.80
Number of new shares (180000/1.80) 1,00,000
Total shares in issue (600000+100000) 7,00,000
Theoretical ex- rights price (1320000/700000) £1.89 per share
New EPS =100*(176000/700000) 25.14 price per share
Form of rights issue (600000/100000) 6, i.e 1 for shares 6
Particulars Right issue price at 1.60
Number of new shares (180000/1.60) 1,12,500
Total shares in issue (600000+112500) 7,12,500
Theoretical ex- rights price (1320000/712500) £1.85 per share
New EPS =100*(176000/712500) 24.7 price per share
Form of rights issue (600000/112500) 5.5, i.e 2 for 11 shares

Particulars Right issue price at 1.40
Number of new shares (180000/1.40) 1,28,571
Total shares in issue (600000+128571) 7,28571
Theoretical ex- rights price (1320000/728571) £1.81 per share
New EPS =100*(176000/728571) 24.16 price per share
Form of rights issue (600000/128571) 4.50, i.e 2 for 9 shares
Interpretation-It is observed that the theoretical ex- right issue share price is lower than the current price
of the share. The actual price or per share also depends on the other factors such as how the new funds are
used and what will be the effect of the issue on EPS. Current EPS is (90000/400000)*100= 22.5 Pense
per share. The issue price falls effect will be on the dilution of EPS I.E. (600000/400000= £1.50)
5) Company should select best option 6, i.e. for 6 shares because in this case EPS will be highest
of other two options available. Also, Theoretical ex- price right issue share price is higher in this option
than other two options available. Shares issued under this option are also less than that of other option.
Thus, company should go selection of 1st option which is beneficial for company than other two options.
C) Definition and advantages of scrip dividend from the point of view of company and shareholders
Dividend:
The term dividend can be defined as a return on the investment made by shareholders
into the company. A company pays a fix amount or a fix ratio of profit to its shareholders as a
dividend equal to the ratio of quantity of shares held by them.
Scrip dividend:
At the time of paying dividend, the company can provide an option to its shareholders to
either take cash or take new shares of the company equivalent to the value of dividend to be paid
to them (Antonides, 2015). This type of optional dividend is known as scrip dividend.
In other words, it can be said that Scrip dividend is nothing but a process of paying
dividend to the shareholders by giving them a choice of receive cash at some future date, or
receive the common stock i.e. new shares of the company.
Advantages of scrip dividend from the point of view of company:

Scrip dividend provides benefits to both shareholders and the company. Its advantages
from the point of view of company can be analysed as under:
 Increase retained earning: By providing choice to shareholders the company can easily
increase the amount of retained earnings held by it that can be used by firm for further
business operations (Scrip Dividend: Advantages & Disadvantages. 2017). In this regard,
it can reduce the need of generating additional funds for running the company.
 Increase size of shareholding without incurring any additional cost: For the purpose
of increasing the size of holding, a company would need to incur some additional cost of
issue. If company provides scrip dividend to its shareholders, it would become able to
analyse issue more shares to its existing shareholders and increase its size of holding
without incurring any additional cost (Scrip Dividend: Advantages & Disadvantages,
2017). As the new shares are issued in terms of dividend.
 Lowers requirement of funds to be paid as dividend: A company requires a huge
amount of liquidity with the company for paying divided to its shareholder. Paying
dividend through this system helps in reducing the need of funds with company as those
shareholders that have adopted option of getting new shares of company instead of cash
would not be needed to pay cash.
 Reduction in company's gearing ratio: With the help of reducing requirement of funds
to be paid as dividend, company can reduce ratio. A higher gearing ratio shows
incapability of company in borrowing funds from market. In this regard, this option helps
in reduce the gearing ratio and hence increase borrowing capacity of business. Tax saving: Scrip dividend also helps the company in terms of tax sharing. The company
provide advantage of tax saving in some circumstances such as tax relating to payment of
cash dividend, regarding issue of new shares, etc.
Advantages of scrip dividend from the point of view of shareholder:
Along with company, the scrip dividend process also provides a range of advantage to
shareholders of the company as under:
 Increasing shareholding in company in Cost effective manner: If a shareholder want
to increase its shareholding in company or to buy more shares of the company, it needs to
incur the expenses relating to transaction cost such as broker's commission, cost of

purchase of shares, etc. These cost can be saved for shareholders by providing new shares
to them for free in terms of dividend (Scrip Dividend, 2018)
 Helps in taking choice as per their convenience: Prospective towards the company
differs by person to person. In this regard, the decision regarding either to maintain,
increase of reduce the shareholding in the company may differ from shareholder to
shareholder. The scrip dividend helps the shareholders in taking choice regarding their
shareholding in the company as per their convenience (Scrip Dividend, 2018). For
example, if they want to increase the amount of shareholding in the company, they can
opt to take new shares rather than cash as dividend. On the other hand, if they want to
maintain the same level of shareholding in the company or in need of cash for fulfilling
their financial needs, they can opt the option of cash as dividend.
 Increase the position in company: By adoption option of receiving common stock
instead of cash for dividend purpose in the company, the existing shareholders can
increase their position in the company without suffering from any pain relating incurring
any transaction cost or a huge process of making transaction of purchasing new shares of
the company (Wensveen, 2018).
In this regard, it can be seen that payment of dividend with by utilising the scrip dividend
system, the managers can lead in providing a huge amount of benefits to both shareholders and
the company.
Disadvantages of scrip dividend :
QUESTION 3
(a) Calculation of Investment Appraisal techniques whether to go investing in the project or not
Yea
r
Annual cash
inflow
Annual cash
outflow
Less:
depreciation
EBIT/EBT/
EAT
Add:
depreciation
Cash
inflow
1 105000 15500 64000 25500 64000 89500
2 105000 15500 51200 38300 51200 89500
3 105000 15500 40960 48540 40960 89500
4 105000 15500 32768 56732 32768 89500

5 105000 15500 26214.4 63285.6 26214.4 89500
6 105000 15500 20971.52 68528.48 20971.52 89500
i. Payback period-
Year Cash inflow Cumulative (£)
0 -320000 -320000
1 89500 -230500
2 89500 -141000
3 89500 -51500
4 89500 38000
5 89500 127500
6 121500 249000
3 years+ 51500/89500= 0.6
Payback period 3 years and 6 months
Interpretation- From the above evaluation, it is been interpreted that the payback period for the
project is been resulted as 3.6 years which means 3 years and 6 months. This is time which the project
will be taking in order to reach the break-even point.
ii. Accounting rate of return-
Year Net cash Flow (£) Depreciation (£) Profit (£)
1 89500 -64000 25500
2 89500 -51200 38300
3 89500 -40960 48540
4 89500 -32768 56732

5 89499.6 -26214 63286
6 121500 -20971 100529
Total Profit 332887
Useful Life 6 years
Average Profit £55,481.17
Accounting rate of return= Average Profit/ Initial Investment *100
Average Investment= Initial Investment + Residual Value
= (320000+32000)/2
= 176000
ARR = £ 55481/£ 176000*100 =32.00 %
Interpretation- From the above analysis, it been viewed that the percentage return from the
investment made by the company in the project equated to 32.00%. This clearly states that the project is
facilitating the greater returns against the cost incurred in the investment.
iii. Net present value-
Year Cash
inflow
PV factor @
12%
Amount ((£)
1 89500 0.893 79910.71
2 89500 0.797 71348.85
3 89500 0.712 63704.33
4 89500 0.636 56878.86
5 89500 0.567 50784.7
6 121500 0.507 61600.5

Sum of discounted cash
flows
384248
Less: initial investment 320000
Net Present Value 64248
Interpretation- From the above analysis it is been observed that the net present value resulted as
64248 which is a positive value. This means that the project is highly profitable and is the best
opportunity for the organization in which the investment could provide higher returns.
iv. Internal rate of return-
IRR= Lower rate used+ [Positive NPV/ (Positive NPV- Negative NPV)]* (Higher rate- Lower rate) %
IRR = 12% + [64,248/(64,248-3,541)]* 7%
= 12% +[64,248/67,789]*7%
= 12% + (0.95*7%)
=12% + 6.6%
IRR = 18.60%
IRR Workings
Note 1:- CPVF (for 5 years) = 89,500*3.058= 273,691
Note 2:- Present value for the 6th year= 121,500*0.352= 42,768
Note 3:- Present Value = 273,691+ 42,768 = 316,459
Note 4:- 3,20,000-316,459 = -3,541
Interpretation- From the above calculations, it is been identified that 18.60% of internal rate of
return is considered as the good rate. The greater the IRR, higher returns are expected from the project but
the risk aspect is more. This depicts the positive outcome from the potential investments as it is counted
as the discount rate which makes the NPV of each and every cash flows from the specific project equated
to zero (Walthoff‐Borm, Vanacker and Collewaert, 2018). The internal rate of return is been
compared to rate of discount in order to evaluate the selected project should be perceived or not. As the

IRR in this project is greater than discount rate, so this project is said to be good.
(b) Company should go investing in the project because the project is showing positive results in
all the three techniques of the investment appraisal. Project IRR and ARR are also much higher
than the 12% of cost of capital. Net Present Value of the company is showing positive even after
the cash outflows.
B) Critical evaluation of benefits and limitations of different investment appraisal techniques
Investment appraisal techniques:
When a company has an extra amount of liquidity with it, managers of the company
should take decision to invest the excess of fund and generate pr5ofit from the investment rather
than to put it with the company and not utilising it for investment purpose. For the purpose of
investing the fund, there can be several investment options available for the business (Howells,
Sauer and Shanklin, 2016). Choosing the best option for investment purpose can increase the
profitability of the company. Further, by choosing the best investment option can help the firm in
improving its financial position.
The financial management provides various methods such as net present value method,
pay back period method, etc. through which the managers of a company can determine the
profitability of a specific investment. These methods provide several guidelines and procedure of
calculating the net income that would be generated by the company from specific investment.
Managers of the company can use any of the method for calculating the actual profit or return
that would be generated through investing that option. By calculating return from the two or
more investment decisions, the company can choose the most appropriate option or project for
the company through which the business would be able to generate the maximum amount of
return from the investment. For example, in case the company have an exxcesss of fund of
60000 pounds, it has an opportunity to imvest the excess amount and generate more profit for the
company. There may be availability of a range of options available for the company at which it
can invest its funds. In order to generate the maximum amount of profit from the investment. For
this purpose, managers can evaluate several options and determine the amount of profit that can
be generated from the specific option. By comparing these options, they can chose the best
option for the firm and help it in improving its profitability as well.

Some of the important investment appraisal methods available in the financial
management can be evaluated as under:
Payback period method
This method provides result in terms of time involved in gaining return from the
investment made by the company. With the help of this method, the managers calculates length
of time required in gaining back the amount of cash or cash equivalent invested by the firm in the
specific project (Speaker, 2015) . By using this method of investment appraisal, that project is
being selected that takes minimum time in gaining back the amount equivalent to the amount of
cash flow made by business for investing in the project. This method is commonly used by small
scale business organisation for whom the gaining back the amount of cash flow as early as
possible is more important than the amount of net profit that can be generated from a long term
investment.
Advantages of payback period method
 It is the simplest method of investment appraisal technique.
 Choosing the best project among several projects using the technique does not require
any professional skills of the managers.
 It helps the company in choosing the most time effective project for gaining return on
investments . In case the investment is to be made without sacrificing the liquidity of firm, this method
can provide the best result in this regard.
Disadvantages of payback period method
 It does not consider annual cash flow of the project.
 It only considers the length of time taken by the project.
 It does not consider the amount of profit that would be generated through making
investment in the project.
Annual rate of return method
For the purpose of calculating return from the investment through annual rate of return
method, annual profit that would be generated by company by making investment in the project
and average amount of investment required in the project is being taken into consideration.
Following formula is being used for the purpose of calculating Annual rate of return:
ARR = Average Annual operating profit from the project / Average investment * 100%

Or
ARR = Average annual profit from the investment / Capital investment (Average) * 100%
By using this method of investment appraisal technique, the project with the highest
annual rate of return is being selected.
Advantages of Annual rate of return
 It is a widely used method of investment appraisal technique as it requires simple
calculation regarding determining return on the investment.
 It uses all the important information relating to the investment such as profit to be
generated, Initial investment, capital investment, etc. therefore, results derived from this
method can be consider as reliable result . (Grafova and et.al., 2017).. As the ARR is being calculated in terms of percentage, it can be understood easily by the
managers of company for their decision making process.
Disadvantages of Annual rate of return
 It does not consider the time required to be generate profit from the investment.
Therefore, it can provide negative results to those business organisations that can not
invest their fund in long term projects.
 It igoners the requirement of working capital in the project.
 It does not consider the time value of money.
Net present value method
This method can be consider as the best method among another methods of investment
appraisal technique. In this method, managers analyses each cash inflow and cash out flow of the
project for determination of actual profit that would be generated from making investment in the
project. In addition, the future value of the cash benefits to be received by firm buy investing into
specific project with the help of discounting factors. In this regard, managers of the company
becomes able to analyse the present value of money that would be generated by the company by
making investment in a specific project (Bastian, 2016). Furthermore, taken into consideration of
the time value of money increases the reliability of the result. In this method, project with the
highest amount of net present value is being selected by the managers for investment purpose.
Advantages of Net present value
 It provides the most reliable results for taking decision regarding the investment in the
project.

 It contains higher accuracy in determination of actual profit to be generated from any
specific investment option. It utilises each information of project including each cash inflow, cash out floe, future
value of money, etc.
Disadvantages of Net present value:
 It requires profeassional capabilities managers to calculate the amount ofg profit to be
generated from the project.
 It contains a lengthy procedure for calculation purpose (Brooke, 2016) .
 Calculating the amount of profit to be generated from investment is a time consuming
procedure.
Internal rate of return method
This method is similar with the net present value method. This method results in
discounting of the cash flows twice. It can be defined as a percentage of discounting rate to be
utilised for appraisal of investment made in the project (Giannakis and Papadopoulos, 2016). In
this method of investment appraisal technique, the present value of future cash flows of the
projects are being equated with cash inflows. The internal rate of return method provides the rate
at which the net present value of the project would be equal to zero.
With the help of internal rate of return method, the managers become able to calculate the
efficiency of a project in providing maximum amount of return on the investment. In general
those projects are being accepted by the managers which involves lower value of the capital
investment. A project with higher amount of requirement of capital investment are generally
being rejected by the managers while using internal rate of return method.
Advantages of internal rate of return method:
 It provides reliable results as it considers the time value of money while determining the
internal rate of return on the project.
 It helps the managers in determining the economic life or economic value of the project.
 It does not requires managers to estimate the cost of capital required in the project,
through which the accuracy of the result may increase. Choosing the project using this technique results in improving the profitability of
company.
Disadvantages of internal rate of return method:

 Calculation of internal rate of return contains a typical calculation.
 It does not consider recouping of the overall capital expenditure to be made for investing
in a specific project.
 It provides different result from the NPV method in case various project options available
with company are of different size or time (Advantages of Internal Rate of Return
Method, 2019).
In this regard, it can be evaluated that there are various methods available under
investment appraisal technique of the financial management. Each method have their own merits
and demerits. In this regard, the manager should first analyse the need of company regarding its
investment and should select the best method for choosing the best investment project in order to
generate the maximum amount of profit from the investment.
CONCLUSION
From analysis of the above assignment, it can be concluded that adoption of various
methods, tools and techniques of the financial management improves the capability of managers
in improving the financial position of the company. With the help of providing dividend through
scrip dividend technique, manager can improve the efficiency of business in maintaining
liquidity along with providing several benefits to the shareholders. In addition, it can be seen that
with the help of adoption of several investment appraisal technique for choosing the best
investment project can improve the profitability of the company.