Financial Management: Merger and Takeovers, Investment Appraisal Techniques

This report discusses the valuation methods for Trojan Plc and the problems associated with valuation models. It also evaluates investment appraisal techniques and provides recommendations.

Financial
Management

INTRODUCTION...........................................................................................................................1
MAIN BODY..................................................................................................................................1
Question 1- Merger and Takeovers.................................................................................................1
1. Calculate the value for Trojan Plc by using various valuation method...................................1
2. Discussed the problems associated with valuation models with the help of evaluating
advantages or disadvantages........................................................................................................3
Question 2 – Investment Appraisal Techniques..............................................................................4
1. Calculate following investment appraisal technique and give brief recommendations...........4
2. Critically evaluate the Benefits or Drawbacks of different investment appraisal techniques. 8
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
Financial management concentrates on proportions of equity and debt. It is valuable for fund
management, income allocation and capital raising, hedging and managing foreign exchange and
commodity process volatility (Antonopoulos and Hall, 2016). Financial analysts are the ones
who can conduct analysis and determine what kind of resources to rise to finance the company's
investments as well as increase the company's worth to all shareholders depending on the study.
In this report, two questions required to address that is about merger and takeover and the other
one is investment appraisal techniques to evaluate most favourable project to invest.
MAIN BODY
Question 1- Merger and Takeovers
1. Calculate the value for Trojan Plc by using various valuation method
Price earnings ratio: As the P / E ratio has been the most popular indicator of how costly
a stock is, knowing the context & value of all its valuation is important. The PE ratio usually
measures how frequent the buyers are willing to pay for the asset. The study of the P / E ratio
demonstrates the direct connection between the stock price of a firm and its results.
Formula:
Price earnings ratio= Net income/total share outstanding
Particulars Value
Share price £2.05
Earnings per share £0.27
Price earnings ratio £2.05 / £0.27 = 7.59
Interpretation: above calculation reveals that Trojan plc received 7.59 a share for
investors. As a consequence of interest and losses accrued, the overall allotted gross
compensation can be split up by an exceptional deal out or just the firm's question of bids. The
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firm's net payout that year was £ 40.4 million and the absolute exceptional offer is £ 147 million.
Value of each share price is £ 2.05 and earning of single share is £0.27.
Dividend valuation model: This is a dividend based valuation model which depends on a
discounted function to approximate present value of stock price that based on expectations about
its potential success in dividends (Brusca, Gómez‐villegas and Montesinos, 2016). This formula
is used to calculate the price and buyer will realistically normally pay for a share if each year it
pays gradually through dividends.
Dividend Discount Model Fair Value: £ 4.774
Calculation:
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
Calculation:
= 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: Value of Trojan Plc shares is £11.24 and it is calculated with the help of
last 4 years dividend. Free market share prices and beta interest carry on critical roles to assess
the conditions; then the exchange rate is regarded as premium or risk prices because competition
provides a threat to this added incentive. Free board prices are impossible to hinder, due to the
unlikely loss of opportunity for the organizations.
Discounted cash flow method: This valuation model ensures that organization can
represent each spending as a single amount that is totally opposite of current cash value (Brooke,
2016). It is applied to all sorts of investment opportunities by investors, analysts and corporate
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managers. It also include acquisitions and expansions that used by the organizations. There
are few excellently-recognized risks to all the benefits it offers.
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: Value of shares is £ 808 by using discounted cash flow method. Rate pf
discount considered to be 5% and value of profit assumed to be £ 40.4 each year.
2. Discussed the problems associated with valuation models with the help of evaluating
advantages or disadvantages
Price earnings ratio:
 Advantages: Examination of the ratio is also critical for financial decisions; because it
lets investors realize the true value of their money. P / E ratio is beneficial when the
relative attraction of a possible investment is available. It lets investors determine how it
that they will pay for a share based on their current profits, and also shows whether the
demand overestimates or underestimates the business. It helps forecast potential
EPS from which the shareholders determine whatever the fair market value of the stock
will be.
 Disadvantages: Short-term stock rates are influenced by the rumours and perceptions
that cause sentiments (Danes, Garbow and Jokela, 2016). As a result, with time to time, P
/ E ratios would get out of whack before the truth and rationality returns to the buying
public. Be sure that consider the amount over time to and the volatility that comes from
unjustified elation or fears. Management also tries to equal the financial performance by
taking accounting choices that maximize them to satisfy investor needs.
Dividend valuation model:
 Advantages: Dividend valuation concept is very technically oriented. The arguments for
this are solid and unquestionable. Dividends tend to remain accurate over longer periods.
Companies face tremendous variability in metrics such as sales and free cash flow.
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Organizations usually, ensure that dividend payments are only compensated out of cash
that is thought to occur with the company each year. Daily dividend payment is a symbol
that a firm is maturing in its business. Its market is stable and, unless anything dramatic
occurs, there is not much risk of uncertainty in the future. This knowledge is important
for many buyers, who choose consistency to quickness
 Disadvantages: This method only appeals to large prosperous businesses that have
established track record of regularly carrying out dividends. Although it may seem like a
positive idea, manifestly, there is a major trade-off. Investors that invest only in large,
profitable companies continue to lose out on fast growth ones. It is filled with so many
assumptions. There are conclusions that addressed above about dividends. Also there are
theories about rate of growth, interest rates and income taxes. Any of those
considerations are just beyond shareholder influence. That factor decreases the model's
credibility too.
Discounted cash flow method:
 Advantages: The "most effective and efficient" approach for determining investment
decisions is to use a discounted cash flow to decline investments to the NPV (Hashim and
Piatti-Fünfkirchen, 2018). Assuming that the projections in the equations are somewhat
accurate, no other approach performs as well to determine which assets deliver optimum
value. It has a big advantage that it sometimes decreases a savings to a single number. If
the NPV is positive, it is anticipated the investment will be a money maker or if it is
negative, the capital expenditure will be a loser. It helps decisions on individual assets to
be up-to-down. Additionally, the approach helps you to make decisions between
substantially different assets.
 Disadvantages: Discounted cash flow estimation is just as strong as the figures in it. If
those figures are incorrect, then the NPV may be incorrect and can make poor investment
decisions. The model has multiple probability of failure. This method used to create an
enterprise value. They will verify how accurate the figure is by doing a fact check,
analyzing whether the interest generated from the discounted cash flow correlates with
the market cap of the firm; with the company's stock interest as seen on the balance sheet;
or with the valuation of comparable firms. Basically there is no link with the real world.
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From the above discussion it is recommended that the company will follow the P / E ratio as
a value of its shares. It helps the management to make their proposed model to boost the
company's profitability or competitiveness.
Question 2 – Investment Appraisal Techniques
1. Calculate following investment appraisal technique and give brief recommendations
Payback period: It is one of the effective techniques of capital budgeting which are
mostly used by the organizations to evaluator recovery period of their investment (Karadag,
2017). It helps to assess the amount of time anticipated to retrieve the proposal's initial cash
expenditure. Simply, that is the approach used to measure the time needed by consecutive cash
inflows to recoup the costs accumulated in the investments. High payback period is not
beneficial or favourable for the organization because it takes more time to recover money.
Because of that, low payback period should be selected for the investment. Below mention
calculation of new machinery in context of Lovewell helps in evaluating payback period and
allows the managers to understand that, it is beneficial to invest or not.
Formula:
Payback Period = Initial Investment / Cash Inflow
= 275000 / 85000
= 3.79 years.
Accounting Rate of Return (ARR): ARR values represented in percentage form that
show the anticipated financial return on the assets that company has acquired (Loke, 2017). It is
among the firm's easiest or quickest ways of determining returns widely used for project
selection. It is calculated by the average annual profit from the original cost. ARR is the
methodology of capital budgeting which doesn't realize all of the period and earnings of money.
The increasing the return is safer for the investor, meaning the higher earnings is equally
received by the client; the lower return is not competitive. Via this, management determines the
advantages of different organizations as well as makes the necessary choices. Calculating ARR
for the 6 year duration about which they earn the correct payout as can be seen in the
below table. Managers of Lovewell must plan their financial choices properly and make a
decision to choose whether or not give priority to this initiative for investing into new machinery.
The following calculations are as follows:
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Formula:
ARR = Average annual profit / Initial investment * 100
Year CI CO (£) Net Cash flow Depreciation Net cash flow
Year 0 £ 275,000 -
Year 1 £ 85,000 (12,500) £ 72,500 £ 38,958 £ 33542
Year 2 £ 85,000 (12,500) £ 72,500 £ 38,958 £ 33542
Year 3 £ 85,000 (12,500) £ 72,500 £ 38,958 £ 33542
Year 4 £ 85,000 (12,500) £ 72,500 £ 38,958 £ 33542
Year 5 £ 85,000 (12,500) £ 72,500 £ 38,958 £ 33542
Year 6 £ 85,000 (12,500) £ 72,500 £ 38,958 £ 33542
Net Present Value (NPV): This is key tools that organizations use when they take
decisions regarding investment. This includes the comprehensive analysis of cash inflows
happening at various time intervals (Siminica, Motoi and Dumitru, 2017). Cash flow of net
present value depends on real and future time risk. In comparison, the discounting rate is the
most important factor which is necessary for calculating and measuring the NPV at the point of
calculation. When determining the estimated cash balance of each year, NPV assists with the
decreased period. Further it helps management where they have to examine or determine to
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choose whether or not to investment in plan. Calculation of NPV for the new machinery is as
follow:
Formula:
Net Present Value (NPV) = Discounted cash inflow / Initial investment
Internal Rate of Return (IRR): Most companies may use one of the popular investment
appraisal approaches to analyze their decisions and make sure these are either productive or
insufficient. IRR based on a shortened duration dictating the present valuation, and thereby
determining the company's profits (Skimmyhorn, 2016). Until executives make the final decision
on potential spending, it is important to take into account company goals and determine their
spending by using the capital budgeting approach, and take other actions accordingly. In
evaluating rational investment decisions, a manager calculates the IRR, which increases the
return on the business that maximise productivity or future growth. Business is able to examine
the danger with the help of estimating IRR, since higher interest rates suggest a big danger. Low
returns present little challenge, and companies may make decisions and develop growth plans as
necessary. Its calculations are as follow:
Formula:
IRR = Lower Discounted Rate + PV of Lower Discounted Rate – Initial investment / PV of High
Discounted Rate – PV of LDR (HDR – LDR)
Present value @ 12%
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Present value @ 20%
R1 = 12
R2 = 20
NPV1 = £44,033.75
NPV2 = -£ 20,118.75
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Recommendation: From the above calculation it is highly recommended that Lovewell
Company’s managers should take initiative to invest in new machinery. Payback period of this
project is 3.79 years; it means company recover their initial investment within 4 years and
furthest they can invest into new projects (Valencia-Cárdenas and Restrepo-Morales, 2016).
Accounting rate of return of new machinery 25.56 % which is not bad, managers can make their
buying decision on the basis of it as well. On the other side net present value of this project is
44,033.75 that are good enough to make favoutable decisions. In addition, rate of return of
buying new machinery is 17.52 % that is quite enough. From the overall conclusion, it is
recommended that managers of Lovewell should invest into purchasing new machinery which
helps in maximising production as well as profitability. It also maximise the individual as well as
entire business operational performance.
2. Critically evaluate the Benefits or Drawbacks of different investment appraisal techniques
Payback period:
Benefits: Selecting proposal or not is among the most important factor and this ways to
determine the proposal is very helpful for the organizations. Managers may use this approach to
choose the correct amount to pay. Such as a short recovery time would be chosen, as it enables
the business to return from of the initial investment more rapidly.
Drawbacks: At the time of making critical choices, managers will consider the
NPV approach rather than this and where they disregard negative NPV, because it is not
beneficial. This method does not take the capital time value and would instead be cantered on a
set output cycle, although each investment does have the same cash flow as some other
decisions.
Accounting Rate of Return (ARR):
Benefits: ARR lets the businesses make their financial decisions feasible. High return is
beneficial for the organizations (Waxman, 2017). Management agrees to make investment
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decision on the basis of ARR by choosing the most fitting one. This approach recognizes the
importance of accounting, which is often found in the decision making process by the managers.
Drawbacks: Average return projections neglect the overall portfolio cash flow, which is
based on reported revenue as well as typical income forecasts. That will have a more effect on
the different issues that need to be tackled. For these venture evaluation methods, the
implications as well as the actual outcome or feasibility of the enterprise are ignored.
Net Present Value (NPV):
Benefits: NPV is being used by the most businesses to determine their engagement and to
evaluate whether or not entities should invest on the project. Positive NPV acknowledged and
unfavourable NPV ignored because investment with such a proposal is not valuable to the firm.
Management has to make its decisions dependent on the interest in the NPV.
Drawbacks: Managers may use this tool to assess their feasibility or equate it with other
plans, and that cannot be used only though all the capital flows are equal. If the initial investment
is precise, instead that forecasts need not be tested or rendered as it does not yield correct
findings. NPV value is influenced by the cost of capital as it changed, which excludes economic
factors like inflation.
Internal Rate of Return (IRR):
Benefits: This is mainly used to understand the benefits of the company receives
after spending particular proposal and then take further required decisions (Mitchell and
Calabrese, 2019). It will encourage rational decision-making to choose the organisation's most
effective choice. Supervisors make important return based decisions and evaluate which strategy
can help businesses to raise their earnings.
Drawbacks: IRR does not take into account the performance which affects the economics
of scale. It is measured by using hit & trial process, which fails to yield detailed results. Which
is also impacts corporate decision-making processes. There's no other gap in lending or
borrowings though. Due to reduced cost transition, the program will see different returns, so
investment decisions are hard for executives to make.
CONCLUSION
In the above review, it was stated that planning is very crucial to the organisation's financial
scenario. That is the method which is used to identify the profitability of any project where
organization wants to invest to maximise their earnings. Management construct legislation by
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emphasizing organizational efficiency and operational effectiveness. The company embraces the
investment appraisal approach to quantify the various criteria for the assessment and make
financial decisions. This requires payback time, rate of return accounting, IRR, NPV, etc. These
are investment appraisal technique used to evaluate best proposal for business.
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REFERENCES
Books & Journals
Antonopoulos, G.A. and Hall, A., 2016. The financial management of the illicit tobacco trade in
the United Kingdom. British Journal of Criminology, 56(4), pp.709-728.
Brooke, M. Z., 2016. Handbook of international financial management. Springer.
Brusca, I., Gómez‐villegas, M. and Montesinos, V., 2016. Public financial management reforms:
The role of IPSAS in Latin‐America. Public Administration and Development, 36(1),
pp.51-64.
Danes, S. M., Garbow, J. and Jokela, B. H., 2016. Financial Management and Culture: The
American Indian Case. Journal of Financial Counseling and Planning. 27(1). pp.61-79.
Hashim, A. and Piatti-Fünfkirchen, M., 2018. Lessons from reforming financial management
information systems: a review of the evidence. The World Bank
Karadag, H., 2017. The impact of industry, firm age and education level on financial
management performance in small and medium-sized enterprises (SMEs). Journal of
Entrepreneurship in emerging economies.
Loke, Y.J., 2017. The influence of socio-demographic and financial knowledge factors on
financial management practices of Malaysians. International Journal of Business and
Society, 18(1).
Siminica, M., Motoi, A.G. and Dumitru, A., 2017. Financial management as component of
tactical management. Polish Journal of Management Studies, 15.
Skimmyhorn, W., 2016. Assessing financial education: Evidence from boot camp. American
Economic Journal: Economic Policy. 8(2). pp.322-43.\
Valencia-Cárdenas, M. and Restrepo-Morales, J. A., 2016. Evaluation of financial management
using latent variables in stochastic frontier analysis. Dyna. 83(199). pp.35-40.
Waxman, K. T. ed., 2017. Financial and business management for the doctor of nursing
practice. Springer Publishing Company.
Mitchell, G. E. and Calabrese, T. D., 2019. Proverbs of nonprofit financial management. The
American Review of Public Administration. 49(6). pp.649-661.
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