Financial Management: Merger and Takeovers, Investment Appraisal Methods

This document provides an overview of financial management, focusing on merger and takeovers and investment appraisal methods. It discusses the valuation techniques used in these processes and their benefits and drawbacks. The document also includes calculations and recommendations for specific scenarios.

FINANCIAL
MANAGEMENT

Contents
INTRODUCTION.....................................................................................................................................3
MAIN BODY.............................................................................................................................................3
Question 2: Merger and takeovers...........................................................................................................3
Question 3 Investment appraisal methods................................................................................................8
CONCLUSION........................................................................................................................................15
REFERENCES........................................................................................................................................16

INTRODUCTION
Financial management can be defined as a type of field in a company that is connected
with proper management of revenues, costs, return, flow of cash and many other monetary
aspects. By help of this management, it becomes easier for managers of companies to distribute
available financial resources in an appropriate manner (Chandra, 2020). The main aim of project
report is to gain knowledge about various kinds of financial concepts like dividends, investment
appraisal methods etc. In accordance of project brief, there are three questions and out of these
two questions are selected which are related to concept of merger & acquisition, investment
appraisal methods. The report covers information about theoretical and practical implication of
both mentioned concepts.
MAIN BODY
Question 2: Merger and takeovers.
Overview- This task is related to merger and takeovers in which Aztec plc is planning to acquire
Trojan plc. For this purpose, both companies’ financial information is given in order to assess
whether Aztec plc should acquire or not. In order to take suitable decision, a range of methods
has been used along with their calculations which are performed below in such manner:
(a) Price earnings ratio: Share price / Earnings per share
Given information:
Share price £2.05
Number of share outstanding 147 Million
Net income £40.4 Million
Calculation of earnings per share:
Earnings per share: Net income / Number of share outstanding
Earnings per share £40.4 Million / 147 Million
Earnings per share £0.27

Price earnings ratio:
Particulars Value
Share price £2.05
Earnings per share £0.27
Price earnings ratio £2.05 / £0.27 = 7.59
Interpretation: From above calculated value, this can be find out that price earnings ratio
is of 7.59 which is indicating that Trojan plc is generating an effective earning from their
shares. As value of their share is £2.05 on which earnings is £0.27 from each share.
(b) Dividend valuation model:
This is calculated by applying below mentioned formula:
D1 / (1 + k) + D2 / (1 + k) 2 + D3 / (1 + k) 3 + D4 / (1 + k) 4………….
Herein,
D1: Value of dividend for year one
D2: Value of dividend for year two
D3: Value of dividend for year three
D4: Value of dividend for year four
K: Expected rate of return
Given data:
D1 (Value of dividend for year one) 10p
D2 (Value of dividend for year two) 10.5p
D3 (Value of dividend for year three) 11p
D4 (Value of dividend for year four) 12p
K (Expected rate of return) 11%

Entering values in formula:
= 10p (1 + 11%) + 10.5p (1 + 11%)2 + 11p (1 + 11%)3 + 12p (1 + 11%)4
= 10 p (0.11) + 10.5p (0.11)2 + 11p (0.11)3 + 12p (0.11)4
= 11.1 + 10.5 (0.0121) + 11 (0.001331) + 12 (0.000146)
= 11.1 + 0.127 + 0.014 + 0.00175
= £11.24
Interpretation: In accordance of dividend valuation model, this can be find out that value
of share of Trojan plc is £11.24. This value of share has been calculated by help of
considering last four years’ dividend which were paid by Trojan plc.
(c) Discounted cash flow method:
Under this approach, value of share is calculated by applying such formula: CF1 / (1+r)1
+ CF2 / (1+r)2 + CF n / (1+r) n
r: 5%
= £40.4 / (1 + 5%)
= £808
Interpretation: In the discounted cash flow method, value of share is of £808. In the
calculation of share value, discounted rate is considered as 5%. As well as value of profit
is assumed as cash flow for year one that is of £40.4.
(d) Analysis of problems associated with above mentioned valuation methods.

Price earnings ratio: This ratio is also known as PER which represents relation between
company’s share prices and earnings on each share (Rahman and Shamsuddin, 2019). The
ratio is applied by companies in order to make proper valuation of share so that they can
determine whether they are over or under valued. The main objective of using this ratio is to
do analysis of stock of a company so that stock price can be assessed in an effective manner.
This is helpful for investors in order to determine market value of stock of a company in
compared to earnings. Apart from these features, this ratio has some demerits which are
explained below in such manner:
Demerits:
 One of the main drawback of this ratio is that it does not consider debt/financial
structure of a company while assessing the financial statements.
 This ratio does not provide any information about earnings per share growth of a
company. In the case when company is growing quickly then investors may make
investment though price earnings ratio is lower or higher.
 The expectation of investors can lead to inflated prices of stock for whole
industry. This is so because during recession value of shares is under evaluated in
respective to P/E ratio. One the other hands, in the inflation earnings of
companies is evaluated in accordance of currency of particular nation. It can
increase raise the value of PER (Itemgenova and Sikveland, 2020).
 This method is not suitable for those companies who are facing loss. It is so
because this model cannot assess value of losses in the initial phase of business
growth.

Dividend valuation model: It can be defined as a type of model of stock price valuation
which is based on theory that states that stock is worth the total of entire futuristic
dividend payouts. This seeks to measure a stock's fair valuation irrespective of the current
business environment, which takes into account the dividend distribution parameters
which anticipated returns on the sector (Akben-Selçuk, 2020). When the interest derived
from the DDM is greater than the current equity exchange price, then the inventory is
undervalued and applies for a buy, and vice versa. In the formula that is used under this
method value of dividend is considered for the years in which a company pays. Such as
in the context of above company, last four years’ dividend value has been used to make
proper evaluation. This method has some drawbacks which are mentioned below in such
manner-
Demerits:
 The main drawback of this method is that it can be applied only on those stock
which pay dividend. It cannot be applied on those stocks that does not pay any
kinds of dividend. In the case, when there is comparison between small and larger
companies then for small companies, this method cannot be applied.
 In the aspect of evaluating a stock, there are a range of factors which need to be
consider such as customer retention, loyalty, intangible assets etc. While in the
context of above method, these are factors are ignored because this method
considers only dividend factors (Pinto, Robinson and Stowe, 2019).
 In some nations, payment of dividend does not consider beneficial in terms of
taxation perspective. Due to which investors prefer to invest in repurchase of
stock, therefore usefulness of this model becomes null.
 The success of this method is completely based on information which is
mentioned in formula. In the case when, information is wrong the valuation of
stock will also inaccurate. So this is also a negative point for using this method of
stock valuation.

Discounted cash flow method: This is defined as a type of method in which valuation is
done in accordance of future time period’s cash flows (Shamsi, Mahdavi and Paydar,
2020). Under it, valuation of an investment is done for current time period as per the
projection of future that how much amount of fund will be generated under it. It is used
by both investors and owner of business because this contributes in an effective manner
in order to do proper evaluation. This has some drawbacks too which are as follows:
Demerits-
 This is difficult for companies to rely on the outcome which is derived by help of
this method. It is so because under this various kinds of assumptions are made
such as for discounted rate, growth rate etc.
 As well as this model is not suitable for short term investment proposals. It can be
applied only for those investing projects which are larger in size (Laitinen, 2019).
This is because implementation of this model can be expensive for short term
investments.
 This method works properly only if there is net cash flow for more than two
years, in the absence of net cash flows this method cannot be applied effectively.
Recommendation to Aztec plc: On the basis of above review of all methods of valuation
this can be guided to owners of above plc is that they should consider dividend valuation
model. It is so because under this valuation of share is done in an effective manner. On
the other side, in rest of two methods valuation of stock and earnings is done which is
suitable for internal and external stakeholders. In the case when a company wants to
acquire other company then they should apply DVM model so that proper valuation can
be carried out.

Question 3 Investment appraisal methods.
Overview: This question is related to implementation of different investment appraisal methods
in order to find out efficiency of new machinery which is proposed to purchase by Love well
limited.
1. Calculations along with recommendations:
(a) Payback period: In order to find out payback period, there are two formulas which are
applied in accordance of nature of cash flows:
When cash flows are equal: Initial investment / cash flows
When cash flows are unequal: Year before recovery of investment+ Amount to be
recovered / next years’ cash flow
In accordance of given financial data, this can be assessed that there is common cash
flow for all years, hence:
Initial investment: £275000
Cash inflow: £85000
Less: Cash outflow: £12500
Cash flow: £72500
Payback period: 275000/72500
= 3.79 years
Recommendation: from calculation of payback period of machinery, this can be find
out that cost of 275000 pounds will be recovered in 3.79 years. While life of
machinery is of 6 years so above company should purchase this machinery because
cost will be covered within life of machinery.
(b) The accounting rate of return:

Step one:
Step two:
Step three:
Step four:
Recommendation: In accordance of above calculated value of ARR, this can be find
out that new machinery will produce return with a rate of 25.56% for 6 years. The
rate of return is acceptable because with this pace of return, company will surely
cover cost of investment.
(c) Net present value:

Cost of capital: 12 % (R1)
Recommendation: On the grounds of calculated sum of net present value of new
machinery this can be find that current value of project is 44033.75 pounds. This is
indicating that purchasing of machinery will be beneficial for above company
because current value of machinery is positive and higher which is a sign of higher
return in upcoming time period for above company.
(d) Internal rate of return (IRR)

Increase cost of capital at 20% (R2)
R1 = 12
R2 = 20
NPV1 = £44,033.75
NPV2 = -£ 20,118.75

Recommendation: From the above calculated value of internal rate of return, this can be
recommended to above company that they should accept the new machinery because it will be
viable for them. It is so because this project will generate higher amount of return in future for
above company.
2. Critical evaluation of benefits and drawbacks of investment appraisal methods.
(a) Payback period: It can be characterized as a type of method of investment appraisal which is
aligned to process of finding estimated time period to cover cost of investment. Under this
method, only two factors are considered which are cash flows and investment (Ndanyenbah and
Zakaria, 2019). This feature makes it easier to apply in the aspect of any kinds of project. Such
as in respect to Love well plc, this method has been applied which states that cost of their project
will be covered in 3.79 years. It gives an idea to managers about efficiency of project that
whether they should acquire new machinery or not. It has some benefits and drawbacks which
are as follows:
Merits: As mentioned in the above part that this method is easier to implement which makes it
suitable for all kinds of companies whether it is small or large. As well as under this method,
evaluation of efficiency of project can be done in less time and cost. In addition, it can be used
by any person of an organization as this does not require any specific accounting knowledge and
expertise.
Demerits: It has some demerits which makes outcomes less reliable such as under this method
factors like time value of money is ignored (Ayodele, 2019). Due to this it becomes difficult for
users to rely on produced outcome, as time value of money is one of the important factor to
consider when a project is evaluated. As well as in this method all years’ cash flows are not
considered because after recovering cost of investment remaining years’ cash flows are ignored.
(b) Accounting rate of return: This is an another simple approach of investment appraisal
method. Under it rate of return on which a project will produce return in future is measured by
applying a formula. On the grounds of computed outcome under this method, companies take
suitable actions regards to acquiring any financial project (Godbole. and Jayraj, 2019

Alkaraan, 2020). Similar to above method, this also requires few information to provide final
outcome. As in regards to Love-well plc, this method has been applied in order to measure
estimated rate of return which was of 25.56%. This rate of return contributes in an effective
manner to managers to determine whether they should accept proposal or not. Underneath some
merits and demerits of this method are explained in such manner:
Merits: This method has a range of advantages which makes it popular to use as under it
accounting profits are used while in other methods net cash flows are considered for project
evaluation. This feature makes it more reliable and effective method to apply. As well as another
positive point of this approach is that it is simple to use because this is based on formula
calculation which can be performed by anyone inside the organization.
Demerits: The ARR method does not consider time value factor which is an important factor to
consider. This makes outcome less effective and reliable for taking decisions (Bakri Bakri,
2019). In addition to this, under it cash flows are completely ignored which is not so good in
terms of computing efficiency of a project. So these are some key demerits of this method.
(c) Net present value: This is defined as a type of method which is used to compute current value
of a project. Under it, present value of project is measured by deducting amount of investment
from discounted cash flow of the different years (Sinha and Datta, 2020). Under it, value of
discounted cash flow is assessed by help of Present value (PV) factor which is assumed. In
general, this method is known as NPV. In the context of above company, this method has been
applied in order to find out net present value of their proposed machinery. Some merits and
demerits of this method are explained below in such manner:
Merits: The key benefit of using this method is that it considers time value of money factor in
process of computing current value of project. This makes it more effective and efficient method
as compared to above mentioned methods because in above methods this factor was ignored.
Another positive point of this method is that it takes all years’ cash flows to find out present
value of project.
Demerits: The main drawback of this method is that it is complex to apply because of
assumptions related to cost of capital. As well as this assumption makes outcome less reliable

and effective to take long term decisions. In addition to this, under it fixed cost is not considered
for calculating present value of project.
(d) Internal rate of return: It can be characterized as a type of method which is related to process
of assessing actual rate of return of a project. This method is considered as a form of approach
which is too complex to use because it requires proper financial information. As well as only
those persons can apply this method who has enough knowledge about accounting. In regards to
above mentioned company, this method has been applied by accountants to know about
efficiency of new machinery for future. Some merits and demerits of this method are explained
as:
Merits: The main advantage of this method is that it provides accurate results which makes easier
for managers to take suitable actions (Jagun, Daud and Samsudin, 2020). In addition to this,
under it all those factors are included that are compulsory to add on before evaluating efficiency
of a project.
Demerits: The key demerit of this method is that it needs a lot of information about finance and
account. Due to which companies need expert that makes this method costlier and time
consuming. As well as it is suitable for larger projects, this cannot be applied in those projects
who are smaller or have less cash flows.
CONCLUSION
On the basis of above project report it has been concluded that financial management is
one of the key part for successful usage of financial resources of a company. The report
articulates that Aztec plc should consider Dividend valuation model because it is more effective
as compared to other methods of valuation. Along with to this, they can acquire Trojan plc
because in all methods, outcomes are acceptable. From the second part of report this can be
concluded that Love-well plc should purchase new machinery because all methods of investment
appraisal are producing favorable results.

REFERENCES
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