International Finance: Proposal Evaluation and Cost of Capital

This document provides a critical evaluation of a proposal in international finance, including benchmarking financial results, forecasting the impact of the proposal, estimating the cost of capital, and recommendations for improving the viability of the proposal.

INTERNATIONAL FINANCE

TABLE OF CONTENTS
INTRODUCTION ..........................................................................................................................1
MAIN BODY...................................................................................................................................1
a) Benchmarking financial results of client company against the Oxford Instruments and
preferred proxy company. ...........................................................................................................1
b) Spreadsheet model forecasting impact of proposal over next five years of business case and
critical evaluation of proposal using investment appraisal techniques and the benchmarking. . 2
c) Estimate of cost of capital considering risk neutral DVM and risk changing approach
CAPM..........................................................................................................................................5
d) Critical evaluation of proposal as standing and recommendations for improving viability of
proposal. ......................................................................................................................................6
e) Evaluating how company could meet the funding requirements ............................................7
f) Critical discussion of corporate social responsibility raised by proposal................................8
g) Conclusion providing recommendation for the proposal or otherwise...................................9
CONCLUSION ...............................................................................................................................9
REFERENCES..............................................................................................................................11

INTRODUCTION
It refers to broad term which describes the activities associated with the leverage,
banking, capital markets, debt, credit, investments and money. It also encompasses creation,
oversight and the study of banking money, assets, investments and the liabilities making up
financial systems. The report is focused on Wandsleigh Wand ltd which is privately owned firm
focusing over manufacture of the technology products under the licence. The stated aim is to
compete with the Oxford Plc. Benchmark financial results of client company will be provided. It
will cover a spreadsheet model covering the impact of results of the analysis. It will provide
estimate of cost of capital of company. Critical evaluation of the proposal, sources for meeting
funding requirements. Critical discussion of CSR in proposal will also be discussed.
MAIN BODY
a) Benchmarking financial results of client company against the Oxford Instruments and
preferred proxy company.
Profitability Ratios Wandsleigh Oxford Xaar
Sales Growth
(T/o 2020 – T/o 2019) / T/o
2019 14.29% 12.36% 18.31%
Gross Margin (Gross Margin / T/o Sales) 43.75% 53.06% 24.22%
Net Profit Margin EBIT/ T/o 31.25% 10.49% -24.07%
ROCE
EBIT/ Capital employed =
EBIT/(debt+equity) 13.00% 14.00% -16.25%
ROE
Net income / Shareholders'
Equity 17.56% -18.60%
ROTA EBIT/Total Assets 9.13% -13.53%
Asset Turnover Revenue / Capital Employed 133.44% 67.50%
Activity Ratios
Stock Turnover Ratios (Inventory / COGS)*365 141.711 157.60
Receivable Days (Receivables / Turnover )*365 85.670 67.31
Payable Days (Payables /COGS)*365 272.468 71.02
Cash Operating Cycle
(Inventory days+Receivable
days-Payable days) -45.087 153.89
Liquidity Ratios
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Current Ratios
Current Assets/Current
Liabilities 1.2:1 1.332 3.57
Acid Test Ratios
Current Assets-Inventories/
Current Liabilities 0.876 2.47
Cash Ratio
Cash & cash equivalents /
Current Liabilities 0.264 1.69
Gearing Ratios
Debt to Equity Ratios
(Long term debt/ share capital
& reserves )*100 0.138 0.039
Capital Gearing Ratios
(Long term Debt / Capital
employed)*100 0.112 0.034
Interest Coverage Ratio EBIT/ interest charges 10.441 -108.100
Investor Ratios
P/E Price/ EPS 26 N/A
EPS
Net income / shares
outstanding 0.520 -92.1
ROE
Net income / Shareholders'
Equity 0.176 -0.186
Dividend cover EPS/ Dividend per share 0.036 N/A
Dividend Yield
(Dividend per share/ share
price)*100 0.013 N/A
It could be reviewed from the above financial ratios that the financial position of the
client company against the Oxford instruments has to be improved and as regards the Xaar it is
much stable and efficient. Client company Wand has to further increase the efforts and strategies
to improve the turnover. Financial ratios shows that profitability of the clients company is closer
to Oxford. The activities ratios shows that the Wand ltd is required to improve the efficiency of
company. Liquidity of the Wand Ltd is near to benchmark level and stronger than Xaar which is
running negative in liquidity position. It has to increase liquidity a bit more (Kavussanos and
Visvikis, 2016). The gearing ratio of the company has to be reviewed by the company as it is
below the benchmark level. Evaluating the investor ratios it could be identified that the company
is above the benchmark level of returns
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b) Spreadsheet model forecasting impact of proposal over next five years of business case and
critical evaluation of proposal using investment appraisal techniques and the
benchmarking.
Company is planning to update the existing structure of the organisation. They are
planning to develop in new market introducing reliant assets and digital based manufacturing
system that will incur higher overhead cost as compared with direct cost. The company is
planning to adapt new strategies and structuring the operations of business (Iqbal and Mirakhor,
2017). It has adopted to adopt new software and hardware system of the organisation for benefit
of organisation. It is essential for the business to make proper analysis of the proposal for its
benefits.
Cost of the investment
Cost of investment in millions
Software design & improvements 0.5
Computer hardware 2.5
Manufacturing assets including
installation 22
Total 25
For the business proposal it will require the business to make capital expenditures. The
capita expenditures is more capital intensive and the digital environments requires considerable
funds. Company for software design and improvements will require funds of 0.5 million,
computer hardware of 2.5 million and manufacturing assets of 22 million (Lewin and
Cachanosky, 2020). It has to analyse whether company will be able to cover the costs of
proposed investment project or not.
Forecasts for inflows and outflows for business
Year 1 2 3 4 5
Inflows
Redundant cost of staff 6000000 6000000 6000000 6000000 6000000
Reduction in wastage 20000 20000 20000 20000 20000
Outflows
Training Budget 1200000 600000 600000 600000 600000
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Depreciation hardware 1000000 600000 180000 144000 115200
Depreciation manufacturing
asset 4400000 4400000 4400000 4400000 4400000
Specialist staff 800000 1200000 1600000
Energy Usage 50000 50000 50000 50000 50000
Forecast for the inflows and outflows have been made as per the costs that will be
required to be incurred including depreciation and the savings of costs due to the new project.
The inflows and outflows are considered for the 5 years (Ang, 2018). It is essential that the
business makes allocation of resources.
Investment Appraisal techniques
Net Present Value
Computation of NPV
Year
Cash
inflows
PV factor
@ 10%
Discounted
cash
inflows
1 4500000 0.909
4090909.09
090909
2 6500000 0.826 5371901
3 9500000 0.751 7137491
4 12000000 0.683 8196161
5 15000000 0.621 9313820
Total discounted cash inflow 34110282
Initial investment 25000000
NPV (Total discounted cash
inflows - initial investment) 9110282
Internal rate of return
Computation of IRR
Year Cash
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inflows
0 -25000000
1 4500000
2 6500000
3 9500000
4 12000000
5 15000000
Internal rate of return (IRR) 21%
Interpretation
Investment appraisal techniques are used by the business to make evaluation of the
investment proposal to assess whether the project will be beneficial or not for the company. It
could be evaluated from the above proposal that the outcomes of investment appraisal techniques
are adequate. The cash flows from the proposal shows that it will be able to cover the cost of
investments. Net present value which is the technique used for assessing the profitability and
viability of the proposed project. It identifies whether the cash flows are enough for meeting the
cost of investment. The outcomes of the technique shows that the cash flows are enough and it
will be able to cover the cost of project (Hua-Wei, 2018). NPV of the project is positive which
shows that the project is viable. Internal Rate of return is other technique which is used to
assessing the return from the project. It shows return from project in percentage terms. The IRR
of the project is 21% which shows that the return is adequate. Project is providing adequate
return and makes it viable for the business. It could be evaluated from the above analysis of
investment techniques that the proposal company is planning to adopt is viable. The project is
profitable and should be adopted by the company as per the outcomes of investment techniques.
The proposal must have positive NPV and adequate IRR as per project. Company has to
closely monitor the project and its requirement ensuring that the adequate returns are earned
from the investment (Suryawanshi and Jumle, 2016). Also the control over the operational
activities and expenditures have to be maintained for successfully meeting cost of investment.
c) Estimate of cost of capital considering risk neutral DVM and risk changing approach CAPM.
Wandsleigh Oxford
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Cost of Capital
DVM
Dividend 0.8 14.4
Price 125 1140
Growth 0.05 0.04
Cost of equity =Dividend/Price
+Growth 5.64% 5.26%
CAPM
Rf 3.80% 4.00%
Rm 5.00% 7.00%
Beta 2.1 1.16
Cost of equity =Rf +(Rm – Rf)Beta 6.32% 7.48%
Cost of Debt
Debt 5.00% 6.20%
tax 30.00% 30.00%
Cost after tax 3.50% 4.34%
Capital Structure
Equity 120 202.2
Debt 40 47.8
Total 160 250
Weights
Equity 75.00% 80.88%
Debt 25.00% 19.12%
WACC
(Cost of debt*weight)+(cost of
equity*weight) 5.62% 6.88%
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Impact of revised cost of capital on proposal
There are two different methods of measuring the cost of equity which are Dividend
valuation method and other is capital asset pricing model (Khashanah and Alsulaiman, 2016).
They are used for estimating the cost of equity. Dividend valuation method considers dividend,
market price and growth rate of business for measuring the cost of equity. On the other the
Capital asset pricing model calculates cost of equity based on risk free rate, market risk premium
and beta. It is based on the assumption that cost of equity is influenced by the outside market
forces.
In the present case the business model is having cost of capital as 10%. Considering the
revised cost of capital which is 5.62% for Wandsleigh against the benchmark 6.88% of Oxford
instrument. The revised cost of capital will make the proposal more viable as it will increase the
net present value of cash flows due to the reduced discounted rate. There will be positive impact
over the proposal due to this revised cost of capital (Dhankar and Maheshwari, 2016). Higher the
cost of capital lower the NPV which requires project to have higher cash flows and vice versa.
Due to the revised cost of capital NPV will increase making project more viable for the business.
Cost of capital of capital of Wands ltd 5.62% as against the benchmark Oxford
instruments 6.88% is lower. It shows the capital structure of Wands is much adequate. The cost
is lower as it has higher proportion that provides tax benefit to company reducing the capital
cost. However it has to maintain the cost of capital by maintaining the optimum capital structure.
d) Critical evaluation of proposal as standing and recommendations for improving viability of
proposal.
Directors of company are planning to develop in new markets introducing more assets
reliant and the digital based manufacturing systems that will lead to higher level of the overhead
related to the direct cost. Project is aiming to increase capacity and maintaining good position in
the highly competitive international market.
The proposal is adopted for improving the efficiency of the company. The cost of
software design and improvements is higher for the next 5 years. Higher cost will affect the
inflows of business making the projected cost to be decreased. The overall cost of capital
expenditures is 25 million. The capital expenditures are incurred for increasing the productivity
and efficiency of the production process.
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Apart from the above capital expenditures, proposal also requires other costs like increase
in training budget for enabling the staff to work with new machineries and software.
Depreciation on hardware is charged on reducing method and straight line for manufacturing
assets. The use of new machineries will make 250 staff members redundant that will enable
company to save 60% of salary cost which is around 6000000. The proposal also requires new
staff for supporting the operational and technical change in the company. It is proposed that
additional revenue of 15m will be generated by the company. The new process will also reduce
wastage that will be increasing the revenues and return pa from the project (Klioutchnikov,
Sigova and Beizerov, 2017). However there will also be increase in cost of power for operating
the machineries which will increased by 50000.
The proposal seems to be adequate however there are points to be considered in the
proposal like sources through which funds will be raised. It will have direct impact over the cost
of capital affecting the outcomes of proposal. It has to also estimated the actual outflows that will
be generated from adopting the project in business. Other costs such as advertisement, marketing
cost have not been covered for increasing the revenues. The trainings should be made effective
so that staff is able to adopt the change smoothly. It has to also evaluate the scrap values if any
from the disposal of machineries to have adequate analysis and outcomes.
e) Evaluating how company could meet the funding requirements
The proposal is adequate and will enable it to increase the efficiency and productivity.
For the project to be implemented company requires fund. It is one of the most important
decision to be taken in financial planning for any investment project. There are different sources
through which funds could be raised for the project. The management of company should adopt
the source which is most optimum and beneficial for the company (Sandberg, 2018). Company
before raising funds also have to analyse the existing capital structure and the structure that will
be after raising the funds. It will be reflected in cost of capital affecting over cost of company.
Therefore it is essential that source of raising funds must be adequate.
Company is having high equity investment of 120-130 million and raising funds through
this source will increase the cost of equity. The cost of raising funds through equity is higher as
compared with other sources. Source of equity is generally approached by the businesses due to
higher benefits available to company. In this source company is not having any fixed obligation
to make payment of interests. Investors are given proportion of ownership as per their
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shareholdings. It is highly adequate source of raising funds when the company is not in position
of making fixed payments of interest or instalments. Shareholders get voting rights in general
meetings.
The other source through which it could raise funds is by issuing debentures or bonds. It
is source of raising funds from public where they are debenture holders and creditors of
company. They do not get any ownership in the business like shareholders. Company raising
funds through debentures is required to make payment of fixed interest rate till the maturity of
debentures or bonds. It also requires the business to give security of company assets on funds
raised. It is fixed obligation that is required to be paid by the company even when there is
inadequate or no profit in the business (Handriani and Robiyanto, 2018). The cost of debt is
lower as compared with equity financing. Also, the company is available with tax benefits in this
source of finance. The interest expenditure could also be claimed under the income tax.
Lastly, it could also raise funds through banks or financial institutions. Funds will be
granted after the bank evaluates profitability and viability of project. They will grant loan if
proposed project seem viable to them. Loans are also granted at fixed interest where company is
required to make payment in instalments for interest and principal. This reduces the burden of
making aggregate payments like in shares and the debentures. Company is under fixed obligation
to make payments for loan unlike share issue (Cornée, Jegers and Szafarz, 2018). Cost of raising
loan is lower and they are more flexible as compared with any other source of finance. Tax and
other benefits are also available in bank loans.
As per current capital structure, it should raise funds through debentures as it is most
viable as it will reduce cost of capital and will require company to make redemption at end of the
period.
f) Critical discussion of corporate social responsibility raised by proposal
Corporate social responsibility refers to business practices that are adopted by
organisation as responsibility towards the organisation to make allocation of business. The CSR
requires the business to ensure that the interest of stakeholders is not affected from the business
proposals company is planning to adopt. There are various stakeholders that are interested in the
company and it is essential for the business to ensure that their interest is not affected. The
proposal is making capital expenditure for which it has to ensure that pollution control measures
are implemented for the manufacturing units. It will also raise the energy consumption for
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increasing the capacity. It is essential that company adopts practices for the welfare of company.
The other major issue raised by the company is the employees that will be made
redundant due to the new technology and machinery adopted for increasing the capacity and
productivity of company. It is essential for the business to ensure that interest of the stakeholders
are not affected. Making 250 staff redundant due to the business will make the staff to suffer.
Reducing the employees due to adoption of new technology is against the policies and practices
of CSR (Bowman, 2017). As per the business approach, it is essential for the business to make
policies and practices that the employees that are made redundant due to the new project are
employed somewhere else in the business.
The management is required to place the employees in some productive areas instead of
replacing them from job. There could be issues such as strikes or other issues like redundancy
that will not enable the company to implement the change effectively. It is essential for the
business to ensure that the issues related to CSR are resolved. As the employees have been
working for the organisation with full efforts and efficiency it is the responsibility of
organisation to make sure that the policies that affect the business and stakeholders interest are
not adopted.
g) Conclusion providing recommendation for the proposal or otherwise.
It could be evaluated from the overall project that it will involves huge amount of
investment for which it is essential that project provides adequate returns for the same. As
analysed using the investment appraisal techniques that the NPV of project is positive and the
IRR is also adequate. The cash flows from the project are adequate and enough for covering the
cost of project. It will enable the company to make profits from the organisation. The proposal is
viable and should be adopted by the company (De Bortoli and et.al., 2019). Also, as company is
having high equity capital it is recommended to raise funds through debt for getting the benefits
that will be reducing the cost of capital. Also the cost of capital will enable the cost of project
lower.
CONCLUSION
It could be concluded from the above report that the financial management for the
business to effectively utilise the funds. It is essential for the management to analyse the project
before investing the project. Management of the organisation has to ensure that all the factors
that could influence the project are carefully assessed. The profitability of the project are
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assessed using investment appraisal techniques that provide whether it should be adopted or
rejected.
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REFERENCES
Books and Journals
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theory and practice. Springer.
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Springer.
Lewin, P. and Cachanosky, N., 2020. Capital and finance: Theory and history. Routledge.
Ang, J.S., 2018. Toward a Corporate Finance Theory for the Entrepreneurial Firm. FSU College
of Law, Public Law Research Paper.(872).
Hua-Wei, H., 2018. Accounting and finance theory and practice: Future development. Asia
Pacific Management Review.23(2). p.71.
Suryawanshi, P.B. and Jumle, A.G., 2016. Comparison of behavioral finance and traditional
finance: for investment decisions. Int J Commer Bus Manag.5(3).pp.81-85.
Dhankar, R. and Maheshwari, S., 2016. Behavioural finance: A new paradigm to explain
momentum effect. Available at SSRN 2785520.
Klioutchnikov, I., Sigova, M. and Beizerov, N., 2017. Chaos theory in finance. Procedia
computer science, 119, pp.368-375.
Sandberg, J., 2018. Toward a Theory of Sustainable Finance. In Designing a Sustainable
Financial System (pp. 329-346). Palgrave Macmillan, Cham.
Handriani, E. and Robiyanto, R., 2018. Corporate finance and firm value in the Indonesian
manufacturing companies. International Research Journal of Business Studies.11(2).
pp.113-127.
Cornée, S., Jegers, M. and Szafarz, A., 2018. A theory of social finance.
Bowman, H.W., 2017. Toward a theory of membership association finance. Nonprofit and
Voluntary Sector Quarterly, 46(4), pp.772-793.
De Bortoli, D. and et.al., 2019. Personality traits and investor profile analysis: A behavioral
finance study. PloS one.14(3).p.e0214062.
Khashanah, K. and Alsulaiman, T., 2016. Network theory and behavioral finance in a
heterogeneous market environment. Complexity. 21(S2). pp.530-554.
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