Financial Management: Calculation of Book Value and Market Value Cost of Capital for Trust Plc

This report discusses the concept of financial management with a focus on Trust Plc. It covers the calculation of book value and market value cost of capital, recalculation of cost of capital, critical discussion on the introduction of gearing, and evaluation of the relationship between WACC and IRR. It also includes investment appraisal techniques such as payback period, accounting rate of return, net present value, and internal rate of return.

FINANCIAL
MANAGEMENT

Table of Contents
INTRODUCTION .............................................................................................................................................3
Main Body..........................................................................................................................................................3
1. a) Calculation Of Book Value and market value cost of capital for Trust Plc.....................................3
b) Recalculation of cost of capital of the capital and making components to projection of the finance
director......................................................................................................................................................5
c) Critical discussion on whether by introduction of gearing the overall cost of capital has been reduced
to an acceptable level:...............................................................................................................................6
d) Evaluation of relationship between WACC and IRR with respect to the investment. Discuss the effects
of agency problem on potential viable investment for Trust Plc:.............................................................6
2. Compute with the help of various investment appraisal techniques and also provide brief suggestions..7
b) Provide comments on decision made by director and examine related effects of proposal on business.
................................................................................................................................................................11
c) State the benefits and limitations of investment appraisal methods...................................................11
REFERENCES.................................................................................................................................................12

INTRODUCTION
The term financial management is the mechanism which is used in financial accounting to assists the
financial activities of the business enterprise during the financial year. It is a well-designed approach that
provides a manner to carry out each and every business transaction effectively and efficiently (Jorge and
et.al., 2019) . It comes up with the regulation, supervision and classification that takes place in the business
environment. In the following report there are different set of questions that recognises the concept of
financial management. In the report first two questions are answered where the evaluation of market value
and book value debts for the current and revised capital structure of an organisation. The second question
comprises of the numerical data in accordance with the different investment appraisal techniques to
calculate the value of the project and the return on investment. The models associated with the capital
budgeting techniques are also in dividend growth model, price earnings ratio method, discounted cash flow
method. Moreover, in the end report also includes the suggestion for the business enterprise that which
measure would be of a great choice among the various measures.
Main Body
1. a) Calculation Of Book Value and market value cost of capital for Trust Plc.
The cost of capital is defined as the amount of money that a company invest on the asset or a project
to get good returns on the investment (Menon., 2019) . Understanding this concept with an example-
Suppose a business owner buys a paint mixing machinery to make colours and get good amount of return
by using that machine. So, here justification of cost is really important because the purpose is to get good
return to achieve the goal.
Weighted average cost of capital is the cost that a company has to pay to its shareholders. In simple terms, if
a company want to invest in the business and funds are required for the same. Then the owner of that
enterprise can issue some stocks and bonds to the public, in order to attract the investment money from
them. This money is then used by the firm for the investment purpose.
Book value of WACC- It shows the value of the assets that is available to the business enterprise. This
balance amount of asset is in the balance sheet of the company.
Market value of WACC- If the firm evaluates the predicted cost of capital then the weighted average cost of
capital process on the ground of numerous components of the market values (Muczyński ., 2020) . Market
value is called as the rate at which the assets are supposed to exported and imported on the basis of high

mortgage value between the various competitors. Such values needs the elements of special numbers. The
value of kind is available between the two parties that are involved in auction and tend to create the price of
higher transactions.
For the purpose of WACC following elements are supposed to be considered-
(£000)
Particular Amount Weights Cost of capital WACC
Equity share capital 30000 0.5 24.00% 12.00%
Preference share
capital
10000 0.17 7.00% 1.19%
Reserves and
surplus
5000 0.8 (£000) 24.00% 1.92%
Bonds 15000 0.25 10.00% 2.50%
Total 60000 1
WACC 17.61%
Working note-
 The cost of preference shares = 7%
 Cost of bonds= 105
 Cost of reserves and surplus is equal to the cost of equity.

Calculation of market value weighted average cost of capital-
Particular Amount Weights Cost of capital WACC
Equity share capital 76800 0.73 24.00% 17.52%
Preference share
capital
7500 0.07 7.00% 0.49%
Reserves and
surplus
5000 0.05 24.00% 1.20%
Bonds 16050 0.15 10.00% 1.50%
Total 105350 1
WACC 20.71%
b) Recalculation of cost of capital of the capital and making components to projection of the finance
director.
Ms. Zara Green the finance director of the organisation wants to bring am increase in the debt of the
business enterprise so that the reduction in cost of capital can be brought. The are giving a proposal to raise
£16m by issuing the 12 % redeemable bonds. The redeemable bonds are issued at the premium of 5% and
are redeemed after the time period of 7 years (Bakke, Mahmudi and Newton, 2020).
Calculation of bonds can be done by the formula listed below-
= {Interest (1- tax rate) + (Redeemable value – Net proceeds) / N } / {Redeemable value + Net Proceeds / 2)
* 100
= {1.92 (1 – 0.30) + (16.80 – 16) / 7} / (16.80 + 16 / 2 ) * 100
= ( 1.34 + .1143) / 16.40 * 100
= 8.87%
Revised Cost of capital
Particulars Amount Weights Cost Of
capital
WACC
Equity share
capital
88500 0.67 23.12% 15.49%

Preference
share capital
6800 0.05 7.00% 0.35%
Reserves and
surplus
5000 0.04 23.12% 0.92%
Irredeemable
bonds
15000 0.11 10.00% 1.10%
Redeemable
bonds
16000 0.13 8.87% 1.15%
Total 131300 1 WACC 19.01%
c) Critical discussion on whether by introduction of gearing the overall cost of capital has been reduced to
an acceptable level:
When the firm proposes more debt then the overall cost of capital is reduced by 1.70% and then the
WACC will be 19.01%. If the fixed rate cost of capital is higher then the firm has to pay the fixed amount of
interest. And when the business entity has more equity in their capital system then also the firm has to pay
the higher amount in order to fulfil the needs and expectation of its shareholders, because they invest in the
firm for profitable returns (Saptono., 2018). In the case, Faith Plc brings the variance in their capital
structure by giving the ad on to redeemable debt in the capital structure.
d) Evaluation of relationship between WACC and IRR with respect to the investment. Discuss the effects of
agency problem on potential viable investment for Trust Plc:
Primary relationship between the Weighted Average cost of capital and internal rate of return is
equal. It represents that the investment done on the projects takes in account the expectation of market
participation.
Another relation between these two is that the Internal rate of return is higher than the WACC.
Definition of WACC
It reflects bunch of average cost of capital for covering the returns of the organisations shareholders.
Essentially it is useful in context of investors that plan to incest in a business for a longer duration. In other
words it can also state that the internal rate of return possess the summation of all outflow and inflow
becoming nil. The formula for calculating internal rate of return is:

IRR = CF/ (1+r) ^i
Let's talk about the relation between IRR and WACC:
 First relation formed between the two is internal rate of return is recorded to be lesser than
Weighted average cost of capital. Thus it reflects that the investment done in finance based
project plans is away from the demand of competitors present in market or the projected
investment results to be too protective then the consumer pays more for the targets (Bernile,
Bhagwat, Kecskés and Nguyen, 2021).
 The second linkage assessed among two is that IRR > WACC i.e. internal rate of return is
recorded to be higher when compared to Weighted average cost of capital. It helps to display
investment done in financial plans that includes synergy of particular consumer or projected
investment seems to be too positive and the purchasing was created at a bargaining quantity.
 The third relation that can be described between internal rate of return and weighted average
cost of capital is WACC = IRR which depicts that the investment in finance related plans
regard the prospect of market involvement and the purchase value is similar as the fair
valuation of obtain enterprise.
Such association among internal rate of return and weighted average cost of capital depicts as which
tool would serve to be more favourable to use, hence it can be concluded that weighted average cost of
capital would be best technique when compared to internal rate of return due to the reason that WACC
supply returns in accordance to increment of investor and it further is easier to compute bur in case of IRR it
would be useful for forecasting the profitability scale of potential investors in related organisations (Chris
Kraft and PMP, 2018).
2. Compute with the help of various investment appraisal techniques and also provide brief suggestions.
(I) Pay back period: It predicts time required by a company for recovering its initial outlay. It can be
explained as time interpreted by business for reaching its break even point. It does not give any extra
attention or focus on overall fund flow that is being acceptable during the life scale of project plans.
Year Annual Cash
Inflow
Annual Cash
Outflow
Annual Net Cash
flows
Cumulative
Cash
Inflows
0 -588.5 -588.5 0
1 233.7 33.2 200.5 200.5

2 233.7 33.2 200.5 401
3 233.7 33.2 200.5 601.5
4 233.7 33.2 200.5 802
5 233.7 33.2 200.5 1002.5
6 233.7 33.2 200.5 1203
7 233.7 33.2 200.5 1403.5
7 SV 76.505 - 76.505 1480.005
Total 1635.9 -356.1 891.505 1480.005
Payback Period = Number of complete years + (Cash outflow – total inflow till date) / Cumulative
cash inflow
= 2 + (588.5-401) /601.5
= 2 + 0.312
= 2.312 Years
(II) Accounting rate of return: Such methods are helpful in computing the average quantity of cash flow
rendered over a year. Such rates are calculated with the help of annual cash inflow divided by total
years the project runs (Dalal and Thaker, 2019).
ARR = Annual Average Profits / Cost of Investments * 100
= (127.36 / 588.5) * 100
= 21.64%
Where, Annual Average Profits = 1480.005/7
= 121.36
(III) Net present value: This technique is useful in ascertaining the quantity of fund a organisation
would be receiving at the end point of time in relation of present value. Present value can be stated as
valuation of future cash inflow in respect of present value of related futuristic fund inflows (Dewi
and et.al., 2020).
Years
Net
Cash
Inflows
Discounting @ 9% PV of Cash Inflows
1 233.7 0.917 214.3029
2 233.7 0.842 196.7754
3 233.7 0.772 180.4164

4 233.7 0.708 165.4596
5 233.7 0.65 151.905
6 233.7 0.596 139.2852
7 233.7 0.547 127.8339
PV of Cash Inflow (A) 1175.9784
PV of Cash Outflow
(B) 588.5
Net Present Value (A-
B) 587.48
(IV) Internal rate of return: This method is helpful to assess the profitability of the investment
amount which is invested in a chosen project. It is refereed as discounting rate that brings the worth
to zero with the help of net present value which is also explained as discounted cash flow (Grossi,
Ho and Joyce, 2020).
Years
Cash
inflows
Discounting Factor
9%
PV value of cash
inflow
1 233.7 0.917 214.3029
2 233.7 0.842 196.7754
3 233.7 0.772 180.4164
4 233.7 0.708 165.4596
5 233.7 0.65 151.905
6 233.7 0.596 139.2852
7 233.7 0.547 127.8339
Total Cash inflow 1175.9784
Total Cash outflow 588.5
NPV (A-B) 587.4784

Years
Cash
inflows
Discounting Factor
20%
PV value of cash
inflow
1 233.7 0.833 194.6721
2 233.7 0.694 162.1878
3 233.7 0.579 135.3123
4 233.7 0.482 112.6434
5 233.7 0.402 93.9474
6 233.7 0.335 78.2895
7 233.7 0.279 65.2023
Total Cash inflow 842.2548
Total Cash outflow 588.5
NPV (A-B) 253.7548
IRR = Lower rate + Lower Rate NPV/ (Lower Rate NPV – Higher Rate NPV) * Diff. in Rates
= 9% + (587.48 / 587.48 - 253.75) * (20 – 9)
= 9% + (587.48 / 333.73) * 11
= 9% + (1.76) * 11
= 9% + 19.36
= 28.36%
Feasibility: The company can use this plan related to consumption of new storage machineries for the
business. The initial outlay for the machinery would be 588.5 that can be covered by the firm within
a time span of 2.3 years. If comparison is done with total value that the enterprise would be able to
produce over running life cycle of business that would amount to 842.25. The net worth in
terminologies of present time if the business concern put money in business plans then it would
receive 253.75 at the ending of project. The net present value of the project is recorded is positive
that denotes that the company concern might purchase new machineries for growth and expansion of
its business related operations. The above project reflects a positive NPV which depicts that after
successful completion of plan the business will generate a adequate and fair quantity of return from
the chosen project. The decision behind purchase of new asset is accurate and firm must move
forward with such decision (Hamid and Loke, 2021).
b) Provide comments on decision made by director and examine related effects of proposal on business.
The decision taken by finance director for selecting 50% of inflow of the plan is consumed in
repurchase of capital related to equity and remaining amount shall be used for paying cash dividends

towards the at present equity shareholders. The company can use funds for raising promoters shareholding
in organisation that would assist in minimizing the existing debt and liabilities in a business. Buy back of
equity shares can be supported by few set of rules and regulations that are described in legal terms (Hashim,
Salleh, Shuhaimi and Ismail, 2020).
Cash dividend are payable towards investors who have made investment in related businesses.
Investors predict dividend to be received in return of their money invested in firm over a period of time.
Innovative ideas and thoughts are supported by large business possibilities, which would help to
attract new customers from environment that would be useful in finding solutions for related problems. The
company is examined through various tools and methods relating tp Investment appraisal techniques. The
firm can adapt net present value that would help to calculate accurate amount in term of present situation.
c) State the benefits and limitations of investment appraisal methods.
Payback period: It is a method which is useful for calculating time needed for covering expense of
investment. If the payback duration is lesser than it states that the investment made is attractive.
The benefits of Payback period is as under:
It is advantageous for such business firms which incline to make investments in smaller quantity.
Payback period doesn't include in excessive complex evaluation thus they do not consider complicated
factors in account. It is also easy in nature because it is simple to calculate and understand as well.
Such tool of investment appraisal concentrate on how early the money can be reverted back from the
investment that a organisation makes. Such interpretation help in computing the standard of risk with respect
to the planned project which business is planning to invest into (Jorge and et.al., 2019).
The metric is beneficial for the project which would return back amount to company in lesser duration.
Hence it can be said that such tool of capital budgeting focuses mainly on liquidity.
This technique is useful for business by providing protection against the risk factor which are linked
with long term spendings.
Limitations of Payback period:
 It does not provide any assurance that if the payback period results to be short the company would
generate revenues.
 The enterprises cannot depend on such techniques as it does not include discounted rates and other
related factors as well.
Internal rate of return: IT provides help and assistance towards the firm which is useful to understand &
choose better option among available alternatives. This helps in estimation of profit scale that is linked with

certain project plan (Meleshenko, Usanova, Kirpikov and Kim, 2019). The IRR can be helpful and prove to
be beneficial because:
 It is computed by evaluation of interests rates at which the current value of future based cash flow is
equivalent to the capital investment demanded.
 The IRR method does not want the hurdle rate which would make it simple for the business to chose
project that would give the return higher than the cost of capital.
Disadvantage of IRR:
 Another limitation for usage of such method is that it won't report the size of plan when comparison
between investment is demanded.
 It also takes in consideration upcoming cash flow, but it also makes an supposition that future fund
flow can be invested again.
Net present value: It can be described as an accounting standard which examines the variation between the
present valuation's of present value and future based cash inflow over a certain duration (Menon, 2019).
The advantages of NPV are as under:
 It is useful for organisation for providing a idea that the investment made would be helpful for
company or not.
 It counts the risk fundamentals and cost of capital in future projects.
Disadvantages of net present value are stated under:
 It is very complex to use such methods when the task can be compared and each of them has
variation in their life cycle.
 Such tool cannot be implemented towards project that have variation in amount invested.
CONCLUSION
From the above collected data it can be asserted that the company is working for improving the work
performance of organisation. It helps to understand the importance and usefulness of Working capital and
internal rate of return. The report also helps to carry out calculations of net present value and find out ways
that would assess in increasing profitability ratio and revenue scale as well. It also serves as medium to find
ouit various tools and techniques that would contribute in efficient working of business and cutting of costs.
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