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Financial Management Capital Structure - Doc

   

Added on  2020-11-12

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Finance
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FINANCIALMANAGEMENT
Financial Management Capital Structure - Doc_1

Table of ContentsINTRODUCTION...........................................................................................................................1Question 1- Cost of Capital and Capital Structure:.........................................................................1(a) Calculation of Book Value and Market Value cost of Capital (WACC) for Kadlex Plc:2(b) Kadlex Plc revised cost of capital after proposed changes with finance director proposal:.3(c) Critical analysis of integrating new capital:......................................................................3(d) Effect of Short-termism on Agency Problem and Bankruptcy:........................................4Question 2- Long term finance: Equity finance:..............................................................................4(a) Right Issue: ......................................................................................................................4(b) Scrip Dividends:...............................................................................................................9Question 3- Investment Appraisal Techniques..............................................................................10(a) Determination of economic feasibility of project using following investment appraisaltechniques:............................................................................................................................11(b) Benefits and Drawbacks of various Investment Appraisal techniques:..........................15CONCLUSION..............................................................................................................................16REFERENCES .............................................................................................................................17
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INTRODUCTIONFinancial Management is the study of planning, controlling and organizing the financesof an organisation (Allen, Hemming and Potter, 2013). This report takes capital structure, equityfinance and investment appraisal techniques into consideration of Kadlex Plc, Lexbel Plc andHappy Meal Limited respectively. It also evaluates the benefits and drawbacks of scrip dividendsand appraisal techniques like ARR, IRR and NPV.Question 1- Cost of Capital and Capital Structure:Cost of Capital and Capital structure are an important concept for any organization as they helpin determining the proportion in which the debt and equity must be taken so as to derivemaximum benefit at lowest cost possible. Kadlex plc wants to review its capital structure in orderto minimise its cost of capital (WACC). The following calculations have been worked out toachieve the same:Step 1: Calculation of growth (g)Years121 pence223 pence325 pence427 pence528 penceS0*(1+g)n = Sn where, g is growth, n denotes number of years, S0 denotes first dividend and Sndenotes last dividend. [In the above table the number of years will be taken as 4 instead of 5 asthe dividend has increased 4 times between Year 1 and Year 5.]S0*(1+g)n = Sn=> 21*(1+g)4=28=> (1+g)4=28/21=> (1+g)4=1.3333=> (1+g)= (1.333)0.25=> g= (1)- ( 1.0757) = 0.0757 or 7.57%Step 2: To calculate the rate of individual sources of finance(i) Cost of Equity (Ke ):1
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Ke = (Sn*[(1+g)+g])/P0 where, Ke denotes Cost of Equity, Sn denotes first dividend, gdenotes growth rate and P0 denotes current ex dividend share price.Therefore, Ke = (28*[1+0.075)+0.075])/2.65=(28*1.15)/2.65=12.15%(ii) Preference Share (Kp):Kp= (j)/Pf where, Kp denotes Cost of Preference Shares, j denotes Preferential dividendand Pfdenotes current ex dividend preference share price.Therefore, Kp= 7/75 = 9.33%(iii) Irredeemable Bonds/Debt:Kdir= ([j* (1-CT)])*(Po/Pn)where, Kdir denotes Cost of Debt (Irredeemable Bonds), jdenotes interest on debt, CT is Corporate tax rate, P0 is Initial Price and Pndenotes Current Price.Kdir= ([0.10*(1-0.30)])*(100/107) = 0.0654 or 6.54%(a) Calculation of Book Value and Market Value cost of Capital (WACC) for Kadlex Plc:Book Value (£'000)Market Value (£'000)Proposed Value(£'000)Equity(Shares+Reserves)£20,000+£5,000=£25,000(No. of shares* Market price)20000*£2.65= £53,00020,000*£2.85=£57,000PreferenceShares£10,00010,000*£0.75=£7,50010,000*£0.68=£6,800IrredeemableBonds£15,000£15,000*£107/£100=£16,050£15000*£107/£100=£16,050Total Capital£50,000£76,550New Bonds--£15,000*£105/£100=£15750Total --£95,600WACC (for Book Value)= {[Ke*BVe]+[Kp*BVp]+[Kd*BVd]} / Total Capital where,Ke = Cost of Equity (before changes)BVe= Book Value of Equity2
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