TABLE OF CONTENTS INTRODUCTION...........................................................................................................................1 QUESTION 2...................................................................................................................................1 a) Number of share units to issue.................................................................................................2 b) Theoretical Ex rights price......................................................................................................3 c) Expected Earning per share....................................................................................................3 d) Number of rights against the shares........................................................................................4 e) Best option..............................................................................................................................5 QUESTION 3...................................................................................................................................6 a) Identifying feasibility of the project using techniques used in capital budgeting...................6 Payback period............................................................................................................................7 Accounting rate of return............................................................................................................8 Net Present Value.......................................................................................................................9 Internal Rate of Return..............................................................................................................10 b) Advantages and dis-advantages of different tools use in capital budgeting..........................11 CONCLUSION.............................................................................................................................13 REFERENCES..............................................................................................................................14
INTRODUCTION Financial management refers to plan, organize, direct and control financial activities going on in a company like procurement & utilization of the funds of enterprise. This means application of the general managementprinciples over the financial resources of enterprise. Money is needed for making money. Life blood of every business is finance and there should be continuous inflow and outflow of money from business. Soundness of plans, efficiency in production systems & excellent networks for marketing are hampered in absence of adequate & timely funds supply. Financial management is having the same importance in business as marketing and production. Present report will cover the concepts of raising finance. This will provide an understanding about the raising of funds through right issue and the viabilityof project in which company is planning to invest using the capital budgeting techniques. In the present report question number 2 and 3 have been answered where 2 is related to right issue and 3 is concerned with capital budgeting techniques. QUESTION 2 Right Issue Right issue is concerned with raising additional capital by issuing new additional shares to its existing shareholders. Existing shareholders have the right of subscribing the shares unless certain special rights have reserved them for other individuals. Right offer or right issue is form of dividend giving subscription rights for buying the additional securities in company given to the existing shareholders. Where the right are related to equity securities like share in public company, they are non-dilutive pro rata way of raising capital. Shares in right issue are sold through prospectus. Existing shareholders in the issued rights have privilege of buying specified number of the new securities at price specified within the period of subscription (Mazumdar, 2019). In public company right issue is type of public offering. In some cases privilege of right issue is also given to individual such as employees directors, and other employees having ownership in company. Right issue can prove to be useful for most of the publicly traded entities as opposed to the options of dilutive financing. Companies generally prefer equity issues over the debt issues as from the viewpoint of company. Firms mostly go for right issue for minimizing the dilution & maximizing useful life of the tax losses carry forwards. In right offerings control is not changed 1
and no-sale theory is applicable, corporations can preserve the carry forwards tax loss better than any other offerings or dilutive financings (Kampanje, 2018). a) Lexbel is company with profit after shareholders funds of 20%. Company is wishing to raise £180,000 through right issue for expanding the existing business operations. It has assured that the return of shareholders will not be affected from this right offerings. It wants to assess the number of shares that are required to issue, theoretical ex right prices. Effect on expected earnings and the ratio in which shares will be issued to existing shareholders. Financial assessment for the right issue Funds to be Raised£180,000 Market price of Lexbel plc£1.90 Rights options for issue price £1.80,£1.60and £1.40 Profits is generated at 20% on shareholder's fund. Ordinary shares of 50p each£300,000.00 Reserves£400,000.00 Shareholder's fund£700,000.00 Profit after tax(700000*20%) £140,000 a) Number of share units to issue Lexbel is proposing to raise funds of £ 1800000 and the funds will be raised through right offerings. It wants to identify the shares that are required to issue under 3 of the given options by company. Below table will show the analysis of shares which are required to be issued in every option. ParticularsAmount £Amount £Amount £ Number of existing shares600000600000600000 Fund to be increased (a)180000180000180000 Right issue prices (b)£1.80£1.60£1.40 Number of share required to issue (c)= a/b100000112500128571.43 It could be assessed that if company chose to issue right at £1.80 then 100000 shares will be issued, if it goes for £1.6 then 112500 shares will be issued and the last option of £ 1.40 will 2
Paraphrase This Document
Need a fresh take? Get an instant paraphrase of this document with our AI Paraphraser
require 128572 shares for raising the required funds. As the prices of right issue decreases the number of shares for raising the capital will be increasing. b) Theoretical Ex rights price Theoretical ex- right price is defined as estimated prices of shares of company after the right offerings. It is estimated usually as weighted average per share both for new and the existing shares. It represents the market price on the theoretical basis of the shares after right issue. Issue is made to existing security holders of the entity at reduced prices. Right offering cannot be made directly to the outsiders without offering it to the existing shareholders. Rights issues are made for consideration that are given to the shareholders or outsiders. Companies calculate theoretical ex right prices instantly after the last day of right issue. There is a dilutive effect on the share pices because the rights shares are issued at reduced prices (Sandrelli and Ventoruzzo, 2018). Companies in most of the case have theoretical ex right price less than the prices offered in market. Theoretical ex right are measured by adding present market value of the shares which existed before the right offerings to the total funds raised by the sale of right shares Right Issue.2019. Resultant is divided by the total shares left after the right issue completion. Through this company can assess value of share after the issue. ParticularsSituation 1Situation 2Situation 3 Prices for right issue1.81.61.4 Fund to be raised180000180000180000 Number of shares to be issued100000112500128572 Pre Right Issue114000011400001140000 Post Right Issue132000013200001320000 Theoretical ex-right price£1.89£1.85£1.81 c) Expected Earning per share Expected earnings per share is calculated by EPS = (Shares prior to right issue * theoretical ex- rights price) / Current market price Market price of share£1.90 Shares existing at present600000 Return on capital140000 3
ParticularsAmount £Amount £Amount £ Prices for right issue£1.80£1.60£1.40 Fund to be raised£180,000.00£180,000.00£180,000.00 Number of shares to be issued100000112500128572 Pre Right Issue114000011400001140000 Post Right Issue132000013200001320000 Theoretical ex-right price£1.89£1.85£1.81 Value of one right0.010.050.09 Fair value per share95454.5597159.0999350.65 Bonus fractions50619.8352443.8354836.4 Earning per share or Eps595488.72585041.55572136.22 d) Number of rights against the shares. Rights offerings will be made by Lexbel in the ratio of their holdings in the ownership of company. The ratio in which right will be issued will change under every option for issue price available with the company. Below table will provide about the proportion in which shares will be issued on their ownership of shareholdings. ParticularsAmount £Amount £Amount £ Prices for right issue£1.80£1.60£1.40 Fund to be raised£180,000.00£180,000.00£180,000.00 Number of shares to be issued100000112500128572 Existing number of shares600000600000600000 Proportion of new shares against existing shares0.170.190.21 Right shares against existing holding of shares1 for 69 for 483 for 14 At £1.80 company will be issuing 1 right share for every 6 shares in company. In this option 100000 right shares will be issued. At£1.60 company will be issuing 9 shares for 48 shares in company. It will issue 112500 right shares under this option. At£1.40 company will be issuing 3 shares for every 14 shares of company. Company under this option will be issuing 128572 number of right shares. 4
e) Best option The above analysis shows that the option that is most beneficial and suitable for the company is of issuing shares at £1.80. This would be the best option from all the three options available to the company. It will have maximum earnings in comparison with the other available option to the company. Also the number of shares are also less that prevents the spread of profits between increased number of shares (Brown,2018). Also the share price tends to reduce with the increase in number of shares. Therefore choosing this option will least affect the share price after the right offering and the earnings per share. Other two options will not prove to be as beneficial as the above option. c) Shareholders adopting scrip dividends in place of cash dividends. Every listed company is required to pay dividend over their shareholdings. Investors invest their funds in company for generating adequate returns over their investments. Dividends is form of return to the shareholders for their investments. It is distribution of profits earned by company during the year. Dividends are paid at specified percentage by the corporations. Before the dividends are decided approval of shareholders is required to be taken. Board of directors decide the dividend to be declared to its shareholders. Company can pay dividends in many forms like in cash,stocks, any other form.It is paid out of earnings or reserves and unless specified it is not mandatory for company to declare dividend every year. In event of inadequate funds or the expansion plan company can forgo payment of dividends. Scrip Dividends In scrip dividend shareholders are given the choice of receiving dividends either in cash or common stocks or at future on specified time. Scrip dividends are generally issued by company when it is not having sufficient funds for distribution. They are paid when company wants to give it shareholder return for their investment. It is made for giving the shareholders a chance for increasing their share of ownership without having to pay in addition (Hornuf and Neuenkirch, 2017). In this shareholders are given options to receive common stocks of company. Investors are showing interested in receiving scrip dividends rather than the cash dividends. Cash Dividends Cash dividend refers to the dividend received by investors in cash. Cash dividends are paid at specified percentage as decided by the board of directors of company. This refers to 5
Secure Best Marks with AI Grader
Need help grading? Try our AI Grader for instant feedback on your assignments.
transfer of economic value from the company to the shareholders, instead of using the funds for business operations. Cash dividends lower the share prices of companies. Benefits of scrip dividend to company Companies are saving their funds through issue of shares in place of cash dividends by giving them choice to receive shares of company. Liquidation risk can be minimised in this option of the firms. Companies increase their market capitalisation over the stock exchange due to increase in number of shareholders. In the event of insufficiency of monetary funds shareholders can be offered stocks in place of cash. Companies are not required to pay dividend tax over scrip dividends like in cash dividend. Benefits of scrip dividend to shareholders Shareholders receiving shares in scrip dividends are not required to pay any brokerage commission or tax in personal returns. It provides the security holders with more yields of capital and financial gains compared with the cash dividends (Kampanje, 2018). Ownership in the company is increased of the shareholders without any additional payment for shares. Retaining powers and increase in value of assets is provided to the investors. QUESTION 3 Techniques used in investment appraisals a) Identifying feasibility of the project using techniques used in capital budgeting. Company Lowell limitedis proposing to buy new machine of £275,000 for food manufacturing. For calculating whether the project is viable or not various investment appraisal techniques will be used. Project involves signifiant investments of funds therefore to check the viability of project is essential. The techniques used are payback period, ARR, net present value and internal rate of return Project under different techniques 6
Payback period Payback period is used by the analysts and experts to identify the period in which the company will be able to recover the cost of its investment. In the business world it is length of time taken by investment at reaching the break even (Su and et.al., 2018). If the project is not able to recover its cost of investment within the specified time it would prove to be unprofitable for company to adopt such project. Working Note : Initial investments = 275000 Cash flow = Inflow- outflow = 85000-12500 = 72500 Payback period = 275000/72500 = 3.9 years. YearsCash inflows Cumulative Cash Flows 17250072500 272500145000 372500217500 472500290000 572500362500 672500435000 3 Initial Investment275000 0.9 Payback period3.9 Years Recommendations Company will be able to recover the cost of initial investment within 3.9 years. It is not having long pay back period. The payback period shows that project will be generating adequate 7
cash flows for the company through which the cost of investment will be recovered. The cash flows are even through out the year and company should adopt the project as per the pay back period. Accounting rate of return It refers to the returns from the project in percentage terms which company expects from the investment. It is also called average rate of returns. It is financial ratio used in the capital budgeting. Time value of money is not taken to account under this ratio. It is used for calculating returns that are generated from the net incomes from the proposed capital investments (Al- Mutairi, Naser and Saeid, 2018). This is used for identifying whether a given project should be accepted or not. Depreciation = Cost of assets – Scrap value / Life of machinery ParticularsAmount Cost of machine275000 Less- Scrap value (15% of cost of machine)41250 233750 Depreciation = 233750 / 6 = 33958.33 Computation of Average rate of return YearCash inflows 8
Paraphrase This Document
Need a fresh take? Get an instant paraphrase of this document with our AI Paraphraser
133541.67 233541.67 333541.67 433541.67 533541.67 633541.67 Average profit or cash inflow33541.67 Average initial investment275000 average initial investment [(initial investment + scrap value) / 2] ARR12.19% ARR = (33541 /275000)*100 =>12.19% Recommendations The above study shows that adopting this machine will give the company return of 12.19%. As compared with other projects returns is comparatively low. Company makes investments for having adequate rate of return. The machine is providing the rate at which it would not be beneficial to have the machine. The technique is not suggesting to adopt the project further assessment will be made for knowing the viability of project. Net Present Value Analysts and experts measure NPV for knowing the present value of future cash flows. It shows whether the future inflows will be able to recover the present outflows. It is calculated to make the comparisons on same scale. Project is considered as profitable if it is left with the positive NPV (Chadha and Sharma,2019). It is derived when the present value of future cash flows is more than the present outflow. Computation of NPV YearCash inflows PV factor @ 12% Discounted cash inflows 1725000.89364732.14 2725000.79757797 9
3725000.71251604 4725000.63646075 5725000.56741138 61137500.50757629 Total discounted cash inflow318976 Initial investment275000 NPV (Total discounted cash inflows - initial investment )43976 Recommendations NPV of theproject is positive that shows machine should be purchased. Company is having net present value from machine of 43976. NPV is calculated by discounting thefuture cash at the discounting rate. Technique recommend to adopt the machine for business. Internal Rate of Return It is a rate of interest where thepresent value is net present value from cash flows generated from project equals to zero. It is also a technique used in capital budgeting for identifying eh viability of investment (Kengatharan,2016). This is technique is quite similar to NPV. Project is suggested to be installed if he return is high. Calculations of IRR IRR= Lower discounted rate + NPV at lower discount rate/ (NPV at lower discount rate- NPV 10
at higher discount rate) * Higher discount rate- lower discount rate Working notes: Net present value @ 12% Net present value = 297828-275000 =£22828 Net present value @ 18%. Net present value = 253576-275000 = -£21424 Recommendations Above project is giving the IRR of 15.07% that is adequate. Installing machine will be providing the company with return of 15%. The project is adopted when the return generated from the project is higher. Company should adopt the project for achieving the growth and objectives. b) Advantages and dis-advantages of different tools use in capital budgeting. Pay back period 11
Secure Best Marks with AI Grader
Need help grading? Try our AI Grader for instant feedback on your assignments.
Benefits It is easy and simple method of calculating and understanding. Payback period helps management in decision making process It is the fastest method of evaluating the project viability.The technique helps company in reducing risks of losses. Drawbacks It do not consider the cash flows after payback period. The tool ignore the concept of time value of money. Accounting Rate of Return Benefits It is simple and straight method of computation. The technique focus over the accounting of net operating incomes (Net Present Value, 2019).It is used by management for evaluating performance of company. Drawback ARR do not consider time value of money concept. Rate of return is not constant over useful life of the assets. Net Present Value Benefits The tool takes into account time value of money. The tool adopts for conventional pattern of cash flows.Risks factors are considered by the rates of discounting. Drawbacks Discounting rate is difficult to calculate. High NPV may not give return on equity of the company for short term projects. Internal Rate of Return Benefits Internal rate of return considers the time value of money concept. 12
It is not essential to calculate hurdle rate in this technique of investment (Alkhamis and et.al., 2017).It is a simple and easy method of calculating return over project. Drawbacks Other terms associated with the project are not considered. It do not consider economies of scale in its calculations. CONCLUSION The above study shows that the right issue is more beneficial methodof raising capital instead of debt. Prices of right shares affects the existing price of share in market. Right issue is made first to the existing shareholders and than to outsiders. Investments appraisal techniques helps company to identify whether the project will be beneficial or not. This enables the company to protect its funds by checking in advance about the profitability of project. 13
REFERENCES Books and Journals Al-Mutairi, A., Naser, K. and Saeid, M., 2018. Capital budgeting practices by non-financial companies listed on Kuwait Stock Exchange (KSE).Cogent Economics & Finance,6(1), p.1468232. Alkhamis, N., and et.al., 2017. Capital Budgeting and Capital Structure Decisions in Saudi Arabia.Advanced Science Letters.23(1). pp.330-332. Brown, A., 2018. Could Distributed Ledger Shares Lead to an Increase in Stockholder-Approved Mergers and Subsequently an Increase in Exercise of Appraisal Rights.Wm. & Mary Bus. L. Rev.10.p.781. Chadha, S. and Sharma, S.K., 2019. Capital budgeting practices: a survey in the selected Indian manufacturing firms.International Journal of Indian Culture and Business Management.18(4). pp.381-390. Hornuf, L. and Neuenkirch, M., 2017. Pricing shares in equity crowdfunding.Small Business Economics.48(4). pp.795-811. Kampanje, B.P., 2018. Advocacy of minority shareholders on shares rights issue of Malawian capital market.Available at SSRN 3284932. Kengatharan, L., 2016. Capital budgeting theory and practice: a review and agenda for future research.Applied Economics and Finance.3(2). pp.15-38. Mazumdar, S., 2019. Procedural Aspects of Rights Issued and Public Issue of Shares.Journal of Capital Market and Securities Law.2(1). pp.1-5. Sandrelli, G. and Ventoruzzo, M., 2018. Classes of shares and voting rights in the history of Italian corporate law. InResearch Handbook on the History of Corporate and Company Law. Edward Elgar Publishing. Su, S.H.,and et.al., 2018. Application and effects of capital budgeting among the manufacturing companies in Vietnam.International Journal of Organizational Innovation (Online).10(4). pp.111-120. Online RightIssue.2019.[Online].Availablethrough: <http://www.yourarticlelibrary.com/accounting/share/valuation-of-rights-of-a-company- methods-and-calculation/46878>. Net Present Value.2019. [Online]. Available through : <https://cleartax.in/s/npv-net-present- value>. 14