Financial Management Report: Capital Asset Pricing and Valuation

This report provides a comprehensive analysis of financial management techniques, covering capital budgeting, the Capital Asset Pricing Model (CAPM), Net Present Value (NPV), and other valuation methods. It begins with an introduction to financial management's importance in improving business conditions and eliminating market obligations. The report then delves into the evaluation of different securities using the CAPM model and presents a Security Market Line (SML) graph to assess the performance of various securities within a business portfolio. The report also examines the time value of money and deferred perpetuities, calculating present values for constant income flows. Furthermore, the report explores annual equivalent costs, calculating and recommending the best plan based on these calculations. Finally, it uses NPV to evaluate a proposed technology purchase, recommending whether the company should proceed with the investment. The report concludes by summarizing the key findings and providing relevant references.

FINANCIAL
MANAGEMENT
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Table of Contents
INTRODUCTION...........................................................................................................................3
Question 1........................................................................................................................................3
a)..................................................................................................................................................3
b) Capital asset pricing model......................................................................................................3
Evaluation of different securities using CAPM model................................................................3
Draw security market line graph by plotting various securities..................................................4
QUESTION 2...................................................................................................................................5
a) Time value of money and deferred perpetuity.........................................................................5
1. Present value of constant income flows at the beginning of the sixth year.............................5
2. Present value now of the whole income stream.......................................................................5
QUESTION 3...................................................................................................................................5
a) Annual equivalent costs...........................................................................................................5
1. Calculate annual equivalent costs of each plan........................................................................5
2. Recommends the best suitable plan based on above calculations...........................................6
QUESTION 4...................................................................................................................................6
a) Calculate NPV in terms of proposed purchase and resultant incremental cash flow..............6
b) Recommend company to purchase the new technology or not...............................................8
CONCLUSION................................................................................................................................8
REFERENCES................................................................................................................................9
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INTRODUCTION
Management is finance is regarded as one of the important aspect as this will help an
entity in order to improve their existing business conditions. This project has emphasized on
various financial aspects of the firms which facilitate an enterprise in eliminating all kinds of
external market obligations imposed on the business. This report is all about various capital
budgeting technique to be used in evaluating various business projects. Bond valuations will be
considered as most important aspects that increases the existing returns gained by an individual.
Certainty model will be used in this assignment to ascertain the actual mount of net profit in
relation to all the expected costs incurred in the business in the near future. The security market
line graph used by the firm is to evaluate all the securities included in the business portfolio in
order utilizing all their strengths in right place. Skills and the capabilities of the firms will get
increases with the passage of time as capital asset pricing model will be used by the firm in
determining required rate of return which will be compared wit the expected rate of return in
order to comment upon the actual results. Time value concept and deferred perpetuties are used
in the given assignment to analyses the existing performance of the business in relation to the
external market as every business wants to secure specific portion of financial resources in order
to safeguard their future. Protection of income is essential for the business in eliminating external
market obligations that may affect an entity's existing performance as this will be managed in the
best possible manner.
QUESTION 1
a)
b) Capital asset pricing model
Evaluation of different securities using CAPM model
Company name Risk free return Market risk Beta Required rate of
return
(rf+(rm-rf)*b
Prawn Ltd 6% 8% 0.5 (6%+(8%)*0.5
10%
Salmon Ltd 6% 8% 0.8 (6%+(8%)*0.8
12.4%
Shark Ltd 6% 8% 1.2 (6%+(8%)*1.2
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15.6%
Trout Ltd 6% 8% 1.7 (6%+(8%)*1.7
19.6%
Draw security market line graph by plotting various securities
Company name SML Expected rate of return
Prawn Ltd 0.72 10.80%
Salmon Ltd 0.0512 13.00%
Shark Ltd 0.1152 15.60%
Trout Ltd 0.2312 17.40%
Prawn Ltd Salmon Ltd Shark Ltd Trout Ltd
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
SML
Expected rate of return
Illustration 1: Security market line graph
Company name Required rate of return Expected rate of return
Prawn Ltd 10% 10.80%
Salmon Ltd 12.4% 13.00%
Shark Ltd 15.6% 15.60%
Trout Ltd 19.6% 17.40%
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On the basis of above security market line graph the performance of an entity is evaluated
that security market line graph of Prawn Ltd is higher than compared to all other securities
enclosed in business portfolio (Martin, 2016). The comparison of securities expected rate of
return with the required rate of return to determine the undervaluation, overvaluation and
correctly valuation of shares. Prawn Ltd has overvaluation of shares as it has higher value of
SML as compared to expected rate of return. Salmon and Shark Ltd has undervaluation of shares
as their SML is lower than compared to the expected rate of return and on the other hand, trout
ltd is correctly valuated.
QUESTION 2
a) Time value of money and deferred perpetuity
1. Present value of constant income flows at the beginning of the sixth year
= 300000*(1/(1+10%)^6
= 300000* 0.564
= 169342.179
2. Present value now of the whole income stream
Year Cash flow Pv@10% Present value
1 0
2 0
3 0
4 120000 0.6830134554 81961.6146438085
5 220000 0.6209213231 136602.691073014
6 300000 0.5644739301 169342.179016133
Total 387906.484732956
The present value of the cash flow is higher than compare to the deferred perpetuity held
in the business. Time value of concept is regarded as the best suitable concept as compared to the
perpetuity method used by an entity.
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QUESTION 3
a) Annual equivalent costs
1. Calculate annual equivalent costs of each plan
Year 0 1 2 3
Manufacturing
costs 100000
Servicing costs 3000 3000 3000
Year 0 1 2 3 4
Manufacturing
costs 90000
Servicing costs 8000 90000 10000 10000
Calculation of annuity factor for both the plan A and B
A(t,r)= (1-(1/(1+r)^t))/r
Plan A= (1-(1/(1+9%)^3))/9%
= 2.53
Plan B= (1-(1/(1+9%)^4))/9%
= 3.23
Annuity value of project
Cost of project/Annuity factor+ service costs
Plan A= 100000/2.53+9000
= 48505. 47
Plan B= 90000/3.23+37000
= 64780.17
2. Recommends the best suitable plan based on above calculations
Equivalent annual costs is one of the important tool used by an entity owner in order to
Analyse its current costs incurred in the business (Di Benedetto and Kim, 2016). It is that
approach in which operating costs spent on a project will be assessed in relation to consider the
project for the future purpose. Above calculations will facilitate an individual in order to make
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decisions regarding selecting or rejecting a particular plan. It can be seen from the above that
plan A will be selected by the firm as it has lower cost of 16274.7 as compared to plan B.
QUESTION 4
a) Calculate NPV in terms of proposed purchase and resultant incremental cash flow
Particulars 0 1 2 3 4
Initial
investment 500000
Working
capital 35000
Reduced labor
costs 190000 190000 190000 190000
Interest 50000 50000 50000 50000
Depreciation 120000 120000 120000 120000
Expenditure on
overhauling
technology 15000 15000
Profit 20000 5000 20000 5000
Tax@30% 6000 1500 6000 1500
Cash flow 14000 3500 14000 3500
Tenant
compensation 33000
Depreciation 120000 120000 120000 120000
Net cash flow 101000 123500 134000 158500
Year Cash flow PV@12% Present value
0 535000
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1 101000 0.8928571429 90178.5714285714
2 123500 0.7971938776 98453.443877551
3 134000 0.7117802478 95378.5532069971
4 158500 0.6355180784 100729.615427166
Total 384740.183940285
NPV -150259.816059715
Net present value method is modernism technique of capital budgeting whose measure
motive is to earn higher amount of return in the near future. Time value concept used by an
entity my using specific discounting rate in order to analyze the existing cash flows generated by
a particular project of technology (Zou, Tang and Li, 2016). The above mentioned project has
generated net loss in the total period of 4 years. The initial investment is higher which gets
increases to 535000 with the inclusion of 35000 as a working capital in form of current assets.
The above project has generated net loss which increases the chances of rejecting the proposal as
no entity wants to generate loss in the future by investing higher amount.
b) Recommend company to purchase the new technology or not
It can be recommended to an entity not to select the above project as this project has
generated net loss in the future (Kumaraswamy, 2016). In relation to the initial investment of the
project that is 535000 the above project has generated loss of 150260 which is higher that needs
to be reduced in order to enhance an entity's overall performance within a given time span. The
adoption of technology as one of the prospective project will not be beneficial for an entity as it
affected its overall performance. In the above project overhauling of technology is paid for
15000 in gap of 2 years for 2 times in the total period of 4 years of project.
CONCLUSION
It can be concluded from the above assignment which emphasises on determining
existing financial conditions of an entity. This report focuses on the time value of money which
have resulted in higher present value as compared to the deferred perpetuity. This report is all
about Security market line graph prepared with the help of CAP model. Annual equivalent costs
method is used to select plan A as best suitable method. Capital budgeting method is used to
facilitate an entity in selecting the best suitable projects.
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REFERENCES
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public, health, and not-for-profit organizations. CQ Press.
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deprivation. Journal of Family and Economic Issues. 37(3). pp.461-473.
Hallows, K. and White, S., 2016. The Introductory Financial Management Course—Do Students
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income households: comparing perspectives of professionals and families in Portugal.
European Journal of Social Work. 19(6). pp.977-991.
Zou, L., Tang, T. and Li, X., 2016. Journal of Multinational Financial Management.
Kumaraswamy, S., 2016. Impact of Working Capital on Financial Performance of Gulf
Cooperation Council Firms. International Journal of Economics and Financial Issues. 6(3).
Ma, Z., Chen, M. H. and Ampountolas, A., 2016. The Effect of Students’ Perceptions and
Learning Approaches on the Quality of Hospitality Financial Management Education.
Journal of Hospitality & Tourism Education. 28(4). pp.169-177.
Di Benedetto, C. A. and Kim, K. H., 2016. Customer equity and value management of global
brands: Bridging theory and practice from financial and marketing perspectives: Introduction
to a Journal of Business Research Special Section. Journal of Business Research. 69(9).
pp.3721-3724.
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