Managerial Finance

Running Head: Managerial Finance
Managerial Finance
Contents

Managerial Finance
1. Executive Summary....................................................................................................................2
2. Introduction..................................................................................................................................2
3. Investment Appraisal Technique...............................................................................................2
3.1 Net Present Value (NPV)...................................................................................................2
3.2 Payback Method..................................................................................................................3
3.3 Internal Rate of Return (IRR).............................................................................................4
3.4 Accounting Rate of Return (ARR).....................................................................................4
4. Sources of Finance.....................................................................................................................5
4.1 Personal Finance.....................................................................................................................5
4.2 Internal Source of Finance......................................................................................................5
4.3 External Source of Finance.....................................................................................................5
a) Equity Financing..................................................................................................................5
b) Debt Financing....................................................................................................................5
5. Breakeven Analysis....................................................................................................................6
5.1 Margin of Safety..................................................................................................................6
6. Cash Budget................................................................................................................................6
7. Performance Evaluation of Lily Wholesale Company............................................................7
8. Issues to be considered by Matheson Electronics.................................................................8
9. Conclusion...................................................................................................................................8
10. References.............................................................................................................................10
11. Appendix................................................................................................................................11
11.1 Calculation of Net Present Value.......................................................................................11
11.2 Payback Method...................................................................................................................12
11.3 Internal Rate of Return........................................................................................................13
11.4 Accounting Rate of Return..................................................................................................13
11.5 Breakeven Analysis.............................................................................................................14
11.6 Margin of Safety...................................................................................................................14
11.7 Cash Budget.........................................................................................................................15
11.8 Income Statement................................................................................................................16
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Managerial Finance
1. Executive Summary
This project is prepared to assist Matheson Electronics with the decision of selecting
or rejecting the project of launching a new electronic device which could measure
miles an automobile could cover in per gallon of gasoline. Analysis has shown that
company could launch the project as a result of positive NPV and acceptable level of
Accounting Rate of Return. The other reason of selecting the project is that it would
help company in reaping more profit because there are no competitors in the market.
2. Introduction
Every business needs capital to meet its long term needs like expansion, acquisition
of another company or to enter all new market. These funds are required for meeting
the needs arising in day to day business operations which are considered as short-
term needs. So now when the fund is so important for any business organisation,
they think twice before investing in any project. To avoid the risk of loss arising from
the investment done in the project the company employs the investment appraisal
techniques like NPV, IRR, and Payback Period etc. to check the profitability of the
project. To avoid the risk associated with the sales and market variability the
company often carries out the breakeven analysis and calculates margin of safety.
3. Investment Appraisal Technique
3.1 Net Present Value (NPV)
Net Present value is usually employed in the investment industry to make a
proper valuation of the project (Bell, 2017).NPV is used to estimate the return
on the amount invested in the project and then the return is converted into
dollar value of today. This helps the company in understanding whether the
project worth the investment or not. It helps the company in knowing whether
the investment would actually increase the value of the firm or not. The best
part of using NPV as an investment appraisal technique is it consider time
value of money, all the cash flows and also the risks associated with the
future cash flows. There are certain reasons which make the NPV less
attractive. The calculations involved in the NPV are very complex in nature
like estimation of cost of capital. There are certain assumptions which are
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Managerial Finance
taken while computing NPV of any project. Management of the company
needs to take the assumptions in respect of dollar amount as well as timing of
the future cash flows related with the project. Interest rates for the project’s
duration are also assumed. The problem lies in the fact that these
assumptions could or could not be realistic in nature.
The net present value of the project stands at $-180688 (Appendix
11.1).Since, NPV of the project of launching an electronic device of the
company Matheson Electronics is negative we may interpret that the cash
inflow or the revenues to be generated from the project will be lower than the
cost incurred on the project execution. So, the company should not go ahead
with the project launch.
The Matheson Electronics may also go for other methods like Payback
method, Accounting Rate of Return and Internal Rate of return for the project
evaluation.
3.2 Payback Method
The payback period is a very appropriate measure to know about the
duration of time the invested amount in the project would stay at risk. It is
time period in which the investment done in the asset or in a project starts
giving the return. The projects with a shorter payback period are usually
considered and those with longer payback period are rejected.
In case of Matheson Electronics the payback period is coming out to be 7.75
years (Appendix 11.2) which means the amount invested in the launch of new
electronic device will start giving returns after 7.75 years.
However there are certain drawbacks of using this method. First, it does not
consider the life span of the asset and therefore the investor does not come
to know about whether payback period is just before the expiry of asset’s life
or just after the asset’s useful life. The main motive of investment is to earn
profit and every investor wants to know about whether the investment will be
profitable or not. Payback only considers the time period in which the initial
investment will be return by the project but it ignores the element of overall
profitability.
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