Financial Management: Mergers and Takeovers, Investment Appraisal Techniques

This document provides an overview of financial management, focusing on mergers and takeovers and investment appraisal techniques. It discusses the valuation methods used in mergers and takeovers, such as price/earnings ratio, dividend valuation method, and discounted cash flow method. It also explores different investment appraisal techniques, including payback period, accounting rate of return, net present value, and internal rate of return. The document evaluates the benefits and drawbacks of these methods and provides recommendations for decision-making.

Financial Management

Contents
INTRODUCTION.....................................................................................................................................3
MAIN BODY.............................................................................................................................................3
Question 2 – Mergers and Takeovers......................................................................................................3
Question 3: Investment appraisal techniques...........................................................................................8
CONCLUSION........................................................................................................................................16
REFERENCES........................................................................................................................................17

INTRODUCTION
In general, the term financial management can be known as a process of managing
available funds in a manner so that an organization can make proper utilization (Shapiro and
Hanouna, 2019). For companies, management of financial resources is a key of success. In the
absence of managing financial resources, it may lead to cause of higher expenses and lower
revenues. The project report is based on two separate questions which are chosen from available
set of three questions. The question one is related to merger and acquisition in which a company
wants to acquire a small business. In the second question, a financial project is evaluated by help
of different kinds of investment appraisal methods.
MAIN BODY
The brief of this project contains three questions which are distinct from each other. Out of these
three questions, there are two questions which have been chosen that are question two and three.
Below detailed analysis of these selected questions have been done.
Question 2 – Mergers and Takeovers.
Overview of question: In accordance of given scenario, there are two companies which are Aztec
plc and Trojan plc. The directors of Aztec plc are planning to takeover Trojan plc and for this
purpose valuation of company has been done under different models.
Valuation of Trojan plc under below mentioned methods:
(a) Price/earnings ratio- Share price / Earnings per share
The above mentioned formula indicates that there will be need of information about share
price of company as well as earnings per share.
From given brief, below mentioned information can be derived that is as follows:

The above table indicates that value of share price is of £2.05 and earnings per share need
to be calculated whose formula is as:
Earnings per share: Net income/number of share outstanding
= £40.4 Million / 147 Million
= £0.27
Now, we have value of all the data which will be needed to compute price earnings ratio:
Price/earnings ratio: £2.05/£0.27
= 7.59
Interpretation: From above information, this can be stated that price earnings ratio of
Trojan plc is around 7.59 that is measured in order to find out relation between price of
each share and earnings on each share. Along with Trojan plc is performing well in the
context of generating higher return on each value of share.
(b) Dividend valuation method
As per the name of this model, it is based on dividend paid by an organization during a
financial year. It is a formula based method which is implemented in such manner:

Interpretation: On the basis of above approach this can be find out that value of share of
Trojan plc is around 11.24 pounds. In the context of above company, this formula has
been applied by considering value of dividend of last four years paid by them.
(c) Discounted cash flow method
In this method, cash flow of a company is used for valuation. In the context of above
company, this method has been applied in such manner:

Interpretation: On the basis of above calculated value of discounted cash flow, this can be
find out that current value of company is around 808 pounds. This value is an indication
of good performance of above Trojan plc in terms of cash flow.
(d) Analysis of problems associated with above mentioned valuation methods.
Price earnings ratio: This can be described as a form of ratio associated with the
determination of the relationship between the share price and a company's share earnings.
This form of ratio is critical for businesses to accurately valuate a business in terms of
market price (Itemgenova and Sikveland, 2020). Basically, inventory analysis is
conducted to determine the company's stock price calculation. This measure is helpful in
the sense of stakeholders and creditors, because they may equate company's existing
stock valuation with earnings. Using this ratio will contribute to issues or drawbacks that
are discussed in this way below:
Drawbacks:
The key problem with using this formula is that the debt / finance framework which, is
totally ignored and contributes to inadequate valuation
Consumers can not gain statistics on earnings per share growth of the company when
utilizing this formula. As a result, investors do not find it worthwhile to take investment
decisions.
Apart of this, it cannot be applied in some businesses that suffer financial losses. The
explanation behind this problem is that the price-earnings ratio does not assess the
volume of loss over the span of growth during starting time (Rialdy, 2019).
Lastly, investor expectation can result in elevated stock prices for the entire market. The
explanation for this is that share prices may be under-estimated in comparison to the PE
ratio at the moment of recession. Though earnings from firms may be measured at the
time of inflation as per the currency value of each particular country. As a result, the
price-earnings ratio will be greater.

Dividend valuation model: This valuation model is based on the conceptual model that
specifies that inventory is valuable for whole further transactions of dividends. It is
related to calculating the market valuation of the stock irrespective of the current
economic situation that takes into account the different variables in the payment of
dividends. If the interest acquired by DVM is greater than the currency exchange price,
then inventory is deemed undervalued vice versa (Akben-Selçuk, 2020). To calculate
inventory value in this formula, the dividend paid in past periods is assumed. As for the
above valuation of the firm, the dividend of the past four years was used for proper
valuation. This system has some drawbacks that are discussed below:
Drawbacks:
In this method, the only issue is that it should be applied on the stock of certain firms for
which they routinely pay dividends. Like in small companies, this method cannot be
implemented since they don't allow dividend distributions. As a consequence, doing
proper valuation of small enterprises is impossible for big business.
Another downside to this approach is that it takes into consideration just one dividend
valuation element. Besides this, it neglects many other big considerations such as
consumer satisfaction, engagement and much others. Because of this it is not rated as full
valuation model by most businesses (D'Amico and De Blasis, 2020).
Companies of certain countries do not want to offer dividends from a tax benefit
standpoint. As a consequence, investors start focusing on making investment in stock
repurchase. In this scenario the above method fails entirely.
A range of correct details are required for the effective execution of this model. If the
details given is false, the outcome may also be unreliable, which may contribute to false
business valuation.
Discounted cash flow method: This is characterized as a type of approach according to
which a company's value is dependent on the cash flow of the potential time span.
Basically, the key aim of this approach is to figure out the cash flow of the forthcoming
span of time using knowledge from existing fiscal years (Yang, 2020). One of the key
advantages of this approach is that it is utilized by a company's owners and creditors

alike. This is because this approach is helpful in supplying reliable valuation-related
details. However, it does have other limitations such as:
The main downside to this approach is that a range to predictions is rendered under it,
such as operating costs, the future cash flow. Because of those premises, relaying on this
system for valuation can be problematic for businesses.
Apart from this, it is not ideal for investment programs that are expected to finish in less
than a year. This is only suitable for investments that have been named for more than a
year. This is mainly because it can be costly and time-consuming for short-term project
plans (Laitinen, 2019).
The effectiveness of this model depends on more than one year's availability of cash
flow. In the case of fewer information about cash flows it cannot be considered for
valuation.
Recommendation to Aztec plc: It could be recommended to the board of Aztec plc that
they must apply Dividend valuation model for Trojan plc assessment on the premises of
the above listed three valuation approaches. The reasoning for this is that a share
valuation is conducted under DVM that allows to business owners to valuate a specific
business. While there are a number of pitfalls in the rest of two approaches like price
earnings ratio and discounted cash flow, rendering the valuation less successful. Though
these two approaches are mainly useful for evaluating profits and market price, rather
than share price valuation.
Question 3: Investment appraisal techniques.
Overview- This question is focused on the use of different techniques of investment assessment
to make the right decisions. According to the specified scenario, Love-well plc is preparing to
buy a new machinery which will cost about 275,000 pounds. Before making investments in this
equipment, they want to use various approaches to measure its efficiency for upcoming time
period.

Calculation using different kinds of methods of investment appraisal along with
recommendations:
(a) Payback period- Under this system, two types of formulas are described below:
Payback period: Initial investment / cash flow (When there is equal cash flow)
Payback period: Year before recovery of investment + amount to be recover/next years’
cash flow (When there is unequal cash flow)
Recommendation: According to the aforementioned figure, it can be observed that in
around 3.79 years the expense of new machine will be regained. The machinery whose
life is about 6 years but whose expense would be compensated in roughly half years of
whole life. Love-well plc should therefore purchase this new machinery under payback
term in compliance with the estimated result.
(b) Accounting rate of return:

Given information-
Step one:
Step two:
Step three:
Step four:
Recommendation: From the estimated value of ARR above, it can be estimated that new
machinery would produce a return of 25.56%. This level is higher as compared to the
275000 pounds’ expenditure. Thus, this new machinery needs to be purchased by above
the client because of the higher rate of return.

(c) Net present value:
Cost of capital: 12 % (R1)
Recommendation: Based on the net present value of machinery measured above, it can be
observed that the machine value is about 44034 pounds. This valuation of NPV is good
enough to allow the purchase of machine in comparison to the tiny expenditure of 275000
pounds. So Love-well plc 's owner are recommended to purchase this equipment.
(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: This can be proposed to Love-well plc 's owner from above IRR estimate that
they should purchase the machinery. It is so because the IRR is 17.52 percent that is higher. If
the above organization invests in the new machine then they will earn returns at a pace of 17.52,
which is reasonable enough in comparison to project costs.
2. Critical evaluation of benefits and drawbacks of investment appraisal methods.
(a) Payback period- This can be described as a method of investment evaluation approach
related to the process of acquiring estimated time to recuperate cost of investment (Ndanyenbah,
and Zakaria, 2019). In this method, only two variables are required which are cash flows and
value of the project. Another key aspect of this method is that it can be used by small companies
too because it does not have any limitation related to project size, cost etc. As for Love well plc,
this method was implemented which defines the recovery of their cost of the project in 3.79
years.
Merits Demerits
As mentioned in the section above, this
approach is easier to implement, making it
suitable for all types of industry, small or
large. As well as in such a strategy, the
assessment of project success may be carried
out with less time and cost. It can be
performed by any person in an organization,
however, as it does not need any specific
accounting expertise and skills.
It has some drawbacks that make outcomes
less reliable as factors such as time value of
money in this method are ignored. Despite
this, it is troublesome for users to rely on the
result produced, since time value of money is
one of the main factors to note while
reviewing a project.
(b) Accounting rate of return- This is another simple way to evaluate project plans. Under this a
calculation is used to measure the accounting rate of return on a project in the future would be
able to gain income (Godbole and Jayraj, 2019). Using this process, companies take reasonable
action on the premises of decided result to attain any financial project. Similar with the previous
strategy, this also takes limited information to achieve the final outcome. In addition to this, it

offers a clear rate of return which is easier to use for assessing possible return in upcoming timer
period. The users of this method just need to multiply calculated accounting rate of return with
total cost of project with an aim to evaluate efficiency of a project in an effective manner. As for
Love-well plc, this formula was used to measure the 25.56 per cent predicted yield amount.
Merits Demerits
This approach has a variety of advantages that
render it valuable because accounting profits
are considered in it while net cash balances
are included under many methods for project
appraisal (Bakri Bakri, 2019). As well as
another positive aspect of this approach is that
it is simple to utilize because it is based on the
execution of formulas that can be
implemented by anyone inside the
organization.
The method to ARR does not take into
consideration the dimension of time value
which is an essential feature. This makes the
outcome less precise and reliable. Beyond
that, cash flows under it are completely
neglected and due to which it is not so helpful
in terms of the success evaluation of a project.
(c) Net present value- That is defined as a tool used to calculate the current value of a project.
Under it, the present value of the project is determined by deducting expenditure amounts from
the cumulative cash flow of the years (Siziba and Hall, 2019). The discounted cash flow
valuation is determined using the anticipated Present Value (PV) factor of it. As well as
produced value of project can be used for determining existing position of a project.
Commonly, the mechanism is called NPV. This method to determine the net present value of the
machinery was applied in the Love-well plc context.
Merits Demerits
The key benefit in using this approach is that
it involves time value of money dimension in
the process of calculating the present value of
the project. It allows this method more
efficient and successful compared to the
methods mentioned above, because time
The main drawback of this method is that,
considering the cost of capital-related
assumptions makes challenging to execute.
Due to this presumption, decisions are
rendered less reliable and unsuccessful. Apart
from this, it does not contain capital costs for

value dimension has been ignored in the
methods discussed above. Another significant
factor of this method is that the estimation of
the present valuation of the project takes into
consideration total cash flows over years
calculating the present project worth. As well
as this method is not successful in the case
when estimated cash flows are producing
negative outcome at the initial time period.
(d) Internal rate of return- This can be considered as a way of approach related to the process of
deciding the actual cost of return for a project (Jagun, Daud and Samsudin, 2020). This style is
based on a form of formula that is too hard to use because it requires proper financial experience
and expertise. This method can be easier for those persons who have sufficient accounting
knowledge. As for the above-mentioned company, accountants have followed the method to
knowing about the efficiency of new machinery for the potential time period.
Merits Demerits
The greatest advantage of this approach is that
it provides reliable outcomes which make
successful action easier for policymakers.
Furthermore, all significant variables are
included before evaluating a project's results.
Along with this method is voted as one of the
significant approach to make evaluation of a
project as compared to others (Kabanda,
2019). The rationale behind this is that it
consists a systematic process to find out
estimated value of project for upcoming time
period.
The key disadvantage of this strategy is that it
requires a lot of knowledge regarding the
finance and accounts. Because of that
companies need expertise which makes this
method costlier and time consuming. As well
as it is not being relevant in such companies
that are restricted or have less financial
means. In addition to these drawbacks, it can
be applied for those projects which are larger
in size and invested capital amount is huge. It
is not suitable for those projects whose size is
smaller. The rationale behind this is that
under formula, NPV is needed that is possible
to compute on those projects whose cash

flows are higher.
CONCLUSION
Based on the above project review, financial management may be said to be one of the
essential aspects for the successful utilization of the financial resources of an organization. The
study articulates that Aztec plc can accept the Dividend valuation model, since it is more
successful than other valuation models. In addition, they should take over from Trojan plc, as
findings in all valuation models are acceptable. From the second segment of the report, it can be
concluded that Love-well plc must buy new machinery, because certain ways of investment
appraisal produce favorable results.

REFERENCES
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