Calculation of Investment Appraisal Techniques and Valuation of Dragon PLC | Desklib

This article evaluates the economic feasibility of acquiring a machine using investment appraisal techniques and provides a valuation of Dragon PLC using DCF and P/E ratio. It also discusses the benefits and limitations of each technique. Course code and college/university not mentioned.

INDIVIDUAL
PROJECT

Table of Contents
Question 2........................................................................................................................................3
A) Calculation of different investment appraisal techniques and providing recommendations
for the economic feasibility to acquire the machine:...................................................................3
B) .................................................................................................................................................5
C) Evaluation of the benefits and limitation of each of the used investment appraisal
techniques-...................................................................................................................................6
Question-3 Valuation of Dragon PLC.............................................................................................9
A) Price/ Earning Ratio-..............................................................................................................9
B) Discounted Cash Flow Method-.............................................................................................9
C) Dividend Valuation Method-................................................................................................10
D) Critical discussion of the valuation techniques and recommendation with economic
justification-...............................................................................................................................10
REFERENCES..............................................................................................................................13

Question 2
A) Calculation of different investment appraisal techniques and providing recommendations for
the economic feasibility to acquire the machine:
1) Payback period-
Payback Period method
Years cash inflows cumulative cash inflows
1 200.5 200.5
2 200.5 401
3 200.5 601.5
4 200.5 802
5 200.5 1002.5
6 200.5 1203
7 200.5 1403.5
Initial investment 588.5
Payback period 2
0.935162095
Payback period 2 years and 11 months.
2) Accounting Rate of Return-
Years cash inflows
1 200.5
2 200.5
3 200.5
4 200.5
5 200.5
6 200.5
7 200.5
1403.5
Average profit or cash 200.5

inflows
Initial investment 588.5
Scrape value 76.505
Average initial investment 332.5025
ARR 60.30
so the ARR is 60.30%.
3) Net Present Value-
Years cash inflows PV factor @ 8%
Discounted cash
inflows
1 200.5 0.925925926 185.6481481
2 200.5 0.85733882 171.8964335
3 200.5 0.793832241 159.1633643
4 200.5 0.735029853 147.3734855
5 200.5 0.680583197 136.456931
6 200.5 0.630169627 126.3490102
7 277.005 0.583490395 161.6297569
Net present value of inflows 1088.51713
Initial cash outflows 588.5
NPV( total discounted cash
inflows 500.0171296
4) Internal Rate of Return-
Years Cash flows
0 -588.5
1 200.5 0.775193798 155.4263566

2 200.5 0.600925425 120.4855477
3 200.5 0.465833663 93.39964941
4 200.5 0.361111367 72.402829
5 200.5 0.279931292 56.12622403
6 200.5 0.217001002 43.5087008
7 277.005 0.168217831 46.59718017
IRR method 29% 587.9464878
Form the evaluation above it can be recommended that the project looks quite feasible.
With this regard, a range of methods has been used where it has been identified that what was the
feasibility of acquiring this machinery in order to carry out business operations. These
investment appraisals have narrated that this investment idea seems to be highly inclined in the
favour of the organization (Siziba and Hall, 2021)
Yet, the organization is recommended to have well-articulated plan before reaching to
any conclusion. All the investment appraisal plans have presented different sides of the same
project so it would be quite necessary for finance manager to deeply abide with the set of
uniqueness they come up with.
There is strong need to have deeper understanding of the limitations these investment
appraisals are having. For instance, in payback method the residual value has not been taken into
consideration so the outcomes are just showing semi picture. The main aim of the method was to
just enumerate the time which is going to be taken by the organization to revert the revenue
equal to the initial investment. These loopholes are to be dealt in order to make better and
rationale decision (Sarwary, 2019)
The organization must perceive that the methods such as NPV, Payback, IRR, ARR have
supported the notion of making investment but there have been some conceptions, assumptions
before carrying out evaluation so economic feasibility becomes a bit hard to get determined
where these all notions are recommended to be taken into focus.
B)
The proposal of using just 50% capital outlay for the purpose to make buy of equity
capital and the rest of amount should be used to pay cash dividends. The organization seems to
be highly profitable. The overall revenues expected was 233.7m and the outflows were around

33.2m. It is living testimony that the organizational performance is highly satisfactory and
having great ability to turn out better and bigger (Ahamed and Haleem, 2020)
If the organization is making great profit and is in lucrative status, then it is considered to
be a wrong decision to distribute dividend. Walter's theory (Kengatharan, 2018) of Dividend
says that if the organization is making profits and its earnings are more than the cost of capital
then it is supposed to utilize the funds for more investment. The retention rate must be higher.
On the other hands, if the organizational profits are not high and if the internal rate of return is
lower than the cost of capital then it is supposed to distribute profits.
In this case is has been seen that the IRR of the organization is 29% and at the same time
the cost of capital is 8%. It shows that the organization is in position to revert profits if it makes
more investments. But the suggested plan is not looking favourable. The Theory of Walter also
states that the dividend policy is having its direct relationship with the value of organization.
With this respect, it would be fair to conclude that the proposed policy is not suitable and if it
comes into force then would impact the total value of the organization.
As Alleyne, Armstrong and Chandler, (2018) suggested that the organizations are
supposed to keep their amounts invested if they are constantly generating profits and the
organization is able to fulfil the expectations of its investors then it needs to retain the funds
rather than distribution. The decision of investing just 50% could not be cited as a rational or
good decision since there is great scope of making bigger profits so this limitation would not
favour the organization.
C) Evaluation of the benefits and limitation of each of the used investment appraisal techniques-
1) Payback period method:
Advantages-
 This is one of the simplest method. Application and brining understanding of this method
is quite simpler and a layman can even apply and interpret it which makes it first choice.
On the other hands, the method also eradicates vagueness.
 It is totally based on the liquidity factor. If the organization is quite conscious about its
liquidity, then this method suits to them. They can manage their liquidity in more
efficient manner (Nguyen, 2019) It focuses on the time the project is supposed to take to revert the cash outflows in the
form of income. This makes it highly aligning with the aim.

Disadvantages-
 The biggest perils of this method is that it does not consider time value of money which
is very essential notion.
 It does not pay attention on the scrape value so proper understanding is not possible. The
residual or scrape value is very much important since at the end of the life of certain
project or machinery that amount is supposed to be used and if it is not taken into
consideration then would impact the final outcomes of the evaluation (Balarabe, 2020)
 The method only focus on the time the plan or investment will take to revert the initial
investment and does not consider the rest of the life of such project.
2) NPV-
Advantages-
 The biggest advantage or benefit of this method is that it considers time value of money
so the presented outcomes are more aligning with the time.
 The method considers entire life of certain investment which brings utter picture. It is widely known for unambiguous results it presents. There does not exist any for of
roughness and confusion in this method.
Disadvantages-
 If the inputs are not high quality, then the outcomes would be misleading since the entire
quality depends on inputs.
 If the projects are having different size, then this method does not suit to them due to
misleading outcomes it extends.
 the used discount rate may get differ in actual circumstances and final outcomes would
not as same as it states (Vatanparast and Maleki, 2020)
3) Accounting Rate of Return-
Advantages-
 This method is easy to apply due to less calculative nature and also offers easy
interpretation to its users.
 The profitability of certain investment can be assessed handily with the use of this
method. Since accounting rate not only disclose the rate but also brings comparability and
if organization is striving to compare itself with others then it is possible with the use of
this technique.

 It presents the percentage which makes it suitable to bring comparability with sort of
other alternatives.
Disadvantages-
 The biggest issue or limitation of this method is that it does not impart time value of
money which reduced its validity of claim.
 It also ignores the opportunity cost of certain project. If opportunity cost is not being
deciphered then the investment evaluation would not extend proper picture of the
investment and it will be ended up with fuzzy outcomes.
 The technique also ignores the size of project. If the project is quite mammoth or is small
yet the final outcomes or the results of evaluation would not get affected they would not
be considering this relative factors.
4) Internal Rate of Return-
Advantages-
 The best part of this method is that it uses time value of money in order to reach final
outcomes. Time value factor brings high reliability and in the present age where inflation
factor is having its great prevalence then it becomes inevitable.
 There is not any type of hurdle rate which brings clarity of outcomes and also eradicates
sense of inferiority (Nguyen, 2019) The method is quite simpler to be used and apply on certain project. Which makes it a
great choice for investment evaluation and also drives better outcomes.
Disadvantages-
 The biggest jeopardy this method comes up with, is that it does not get affected by the
size of project which topples its reliability and validity.
 On the other hands, also ignores future costs which are supposed to take place due to
longevity of the investment.
According to Balarabe, (2020) it totally depends on the purpose and nature of an
investment, the evaluation technique must align with the aims, and objectives undertaken.
Otherwise, it would be deteriorating final conclusion and may also mislead to make rational
choice of the available alternatives. The views supported by Pratheepkanth, (2022) and extended
his side saying that the usefulness of these methods or investment appraisal techniques depend

on the nature of investment which should be imparted and then the investment appraisal
technique should be used.
There are many theories and strategists who believe that the use of these models are very
sensitive matter for an organization. If they are not being used in proper manner then may
mislead the final outcomes. For instance, if there are tow or many be more projects or investment
alternatives and NPV and PI methods are bing used. Then the NPV would not consider the size
factor and higher NPV would come form the alternative with higher initial cost so the final
decision-making may get misled. At the same time, if at this point PI method is used then the
outcomes would be reliable (DePamphilis, 2019)
Therefore, there is need to have deeper understanding of these models before applying
them it would drop out the possibility of their misuse and misinterpretation. With the help of
technique understanding the methods can be applied in logical manner keeping their
characteristics into focus.
Question-3 Valuation of Dragon PLC
A) Price/ Earning Ratio-
Price Earning Ratio= Market Price Per share/ Earning Per Share
Market Price per share= Current Ex- Dividend Share prices in the market= 2.45
Earning Per Share= 0.29
P/E Ratio=
= 2.45/0.29= 8.45
So The value of Dragon PLC would be= Price Earning Ratio* Distributable Earnings
= 8.45*40.4
= 341.38
So by applying the price earning ratio the value would be 341.38.
B) Discounted Cash Flow Method-
The value of Dragon PLC is being calculated by applying the discounted cash flow method-
Discounted cash flow= Distributable earnings* (1+ Growth Rate)/ (Cost of Equity- Growth Rate)
(Renneboog and Vansteenkiste, 2019)
Distributable Earnings of the organization are= 40.4
Growth Rate= 2.5%
Cost Of Equity= ?

Cost Of Equity= RF( Risk Free Rate) + Beta* ( Market Risk Premium- Risk Free Rate)
Risk Free Rate= 5.5%
Beta valuation= Dragon's Equity Beta value is= 1.05
Market Risk Premium= 6%
Cost of Equity=
= 5.5%+(1.05* (6%-5.5%)
= 5.5%+ (1.05*0.5%)
= 5.5%+ ( 0.525%= 6.025%
Discounted Cash Flows= 40.4*1.025/3.525%
= 41.41/3.525%= 1174.75
So, the value of Dragon Plc has been determined on the basis of Discounted cash flow method is
1174.75.
C) Dividend Valuation Method-
Latest dividend payment D0= 14 P
The dividend supposed to be paid in the year 1= D1= D0 ( 1+g) = 14 (1+2.5%) = 14.35P or
0.1435
Cost of Equity possess by the organization =K= 6.025%
Growth Rate is= 2.5%
Value of the shares of Dragon= P= D* (1+g) / K-g
P= 0.1435/ 6.025%- 2.5%= 0.1435/3.525%= 4.07
So the value of Dragon Plc as per the undertaken method would be= Value of the shares*
Number of outstanding shares=
= 4.07* 145
= 590.15
D) Critical discussion of the valuation techniques and recommendation with economic
justification-
Merger and Takeovers are becoming quite general practise in the corporate world. For
taking advantage of other's synergy and being affective, competitive in the market organizations
come into this position and become part of such collaboration. The Synergy Theory says that if
there are tow or more organizations are getting operated separately then they would not be in

position to take advantage of market dynamics they are having need to come in collaboration and
can ensure higher profitability. It not only favours them in term of economic superiority but also
paves the way to become more affective in term of operations (Sun, 2022)
All the above stated methods are having their great usefulness but it totally lies in the
jurisdiction used by an organization to make sure which method has to be applied when it comes
to their practise. The organization decides it keeping some key areas into focus. Such as their
way of working, operations, size and nature of business etc. These all factors play great role in
determination of the value. The methods and associated problems with them are as-
Price Earning Ratio Method-
This is one of the most usable method for valuation. But there are some issues or
problems. The biggest issue is that this method does not discuss or tell anything about the EPS
growth perspective of the organization. On the other hands, it does not take into consideration
any for of growth. If any organization is having major debt related issues but it considers only
equity prices. There are some other issues too, for instance- the method ignores capital structure
and just align with price earning structure. The risk factor which comes up with debt does not
share any intellect in this model. If the capital structure is diversified then this becomes
inappropriate method to use. In the above case, it can be seen that the organization is having
bond with 7% interest rate so this factor would not be accentuated for such decision-making
which topples its ability to drive better conclusion.
Discounted Cash Flow Method-
This method is being used on wide scale yet the fact can not be ignored that the method is
having range of perils or problems which not only reduce its quality but also bring the validity
and reliability factors under doubt. The biggest issue is that the method requires large range of
assumptions which are used while applying it. Which not only topples its reliability but also
makes it complex. The method is highly sensitive to the changes get imparted due to
assumptions. It does not pay attention to the relative valuation of other competitors. If the
organization is evaluating its own value then it would not bring any clarity about the rivals of the
entity.
Dividend Valuation Method-
The method is well known for the quality it offers. But there are some issues too which
topples its ability to turn out better outcomes. The method does not include non dividend factors

which drops its ability to revert deeper understanding. At the same time, the effects get
inculcated due to stock buyback are not taken into focus under the method. There are number of
thinkers who believe that the method is not much useful due to over simplistic nature it
possesses. There is always need to offer wider diaspora since such valuation techniques are
having their great importance for organization (Balarabe, 2020)
By making deeper evaluation it can be deciphered that the best method or the
recommended method to the Kings Plc is Discounted cash flow method. All the methods are
having their importance but for the entity it is essential to practise the model which eradicates all
the fuzzy notions and can help it to make better decisions. Which is only possible with the help
of the Discounted Cash Flow Analysis method.
There are number of economic aspects are being imparted while driving the suggestion of
using the above extended valuation method. The Characteristic of the organization,
Characteristics of its investors, Purpose of such investments, the structure or capital structure,
profitability factor, comparability, validity, reliability, comprehensiveness etc. These elements
are needed to figure out absolute valuation. The other methods do not suit to the organization due
to lack of sufficiency they are supposed to have.
Kings plc which is striving or planning to acquire the Dragon plc. There are some factors
which are to be considered while making such intensive decisions. With this regard, all key areas
and dynamics were evaluated in order to reflect the best valuation method which can fulfil all
these rational requirements and can drive better repercussions to Kinds plc.
Looking at the rationale behind such acquisition, deeply observing the futuristic
outcomes, consideration to growth rate etc. These all factors can only be instilled if Discounted
Cash Flow method is being used. Kinds Plc is having desire to make this happens which would
be in their favour if they are well aware of the value possessed by Dragon Plc. If the valuation is
not proper then it would lead some misconceptions and final decision-making would also be not
appropriate.
The PE method is having some shortcomings which makes it poor when it comes to
application while valuation. Growth element and risk factors are not given consideration while
applying the theory and the calculations are solely based on Equity Prices. There is need to have
inclusive nature of calculation so can eliminate sense of confusion and can reach to rational

decision. With this regard, the organization is suggested to go with Discounted Cash flow
method.
There are range of economic superiorities this method is having, for instance the cash
flows are the most prominent aspect and when acquisition is being carried out then the main aim
is to bring bigger cash inflows to the organization which can be ensured by application of this
method. Economically it would be a great decision and will aid organization to decipher proper
picture while pursuing the acquisition of Dragon plc.
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selection and use of capital budgeting techniques: evidence of Sri Lanka.
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Sun, B., 2022, July. The Effect of Takeovers on the Performance of Acquirers in
Australia Based on The Economic Value Added Method. In 2022 2nd
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