Strategic Financial Management Assignment (Doc)

Prepare a report to the
Directors of AYR Co. which
includes the following. 1. A
calculation of the N

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
QUESTION 1...................................................................................................................................1
1. Calculation of Net Present Value, Internal rate of return and Payback period for both
Project Aspire and Wolf..............................................................................................................1
QUESTION 2...................................................................................................................................5
1. Recommendation for undertaking project...............................................................................5
2. Justification for recommendation for evaluating investment appraisal techniques................5
3. Summary of other factors for taking final decision................................................................6
QUESTION 3...................................................................................................................................7
1. Description of debt and equity................................................................................................7
2. Explanation of cost of each finance source.............................................................................8
3. Analysis of AYR Co.'s weighted Average cost of capital......................................................9
4. Assessing impact of selection of finance on current and potential lenders and shareholders
...................................................................................................................................................10
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
Investment appraisal is referred to as collection of techniques which are applicable for
determining attractiveness of a particular investment. The present report will critically apply,
assess and evaluates techniques and issues for strategic financial management. This report will
provide significance of net Present value, Internal rate of return and payback period with its
calculation and appropriate interpretation. It will be providing appropriate analysis of option for
investment project along with recommendation and justification. In the same series, it will also
provide summary of factors which must be considered for taking final decision about selecting
project. Further, cost of debt and equity would be provided with proper explanation of cost and
assessment of impact for choosing finance with context of potential shareholders and lenders.
QUESTION 1
1. Calculation of Net Present Value, Internal rate of return and Payback period for both Project
Aspire and Wolf
Net Present Value: It is referred to as value of future cash flow over life of particular
investment which is discounted. This analysis is stated as valuation of intrinsic form which is
applicable in extensive aspect in whole accounting and finance for identifying business's value,
capital project, investment security, cost reduction program, new venture and engagement of
cash flow. Generally, it is used for identifying amount of investment project along with series of
worth cash flow (Al-Mutairi, Naser and Saeid, 2018). It is stated as encompassing metric which
is accounted as expenses, revenue and association of capital cost along with investment in Free
Cash Flow.
By factoring cost and revenue, it considers timing of cash flow whose outcome have huge
impact on investment's present value. In the similar aspect, cash flows are discounted because of
adjusting risk in opportunity of investment and for accounting time value of money. It is
necessary as each business does not have similar level of risk. In simple words, risk could be
accounted and there is presence of high discount rate for riskier investment and less for safe one.
NPV is also required for interest rate, opportunity cost and inflation where money is valuable
when it is received.
Project Aspire
Net present value
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Year Cash flow 10.00% PV at discounted
1 579000 0.9091 526364
2 616542 0.8264 509539
3 656911 0.7513 493547
4 700318 0.6830 478327
5 746994 0.6209 463825
Total cash 2471601
Cash outflow 2250000
Net present value 221601
Interpretation: The above table is indicating net present value of Project Aspire as its
final outcome of this investment is worth $221601. In simple words, AYR Co. has will to repay
$221601 each year over 5 years.
Project Wolf
Net present value
Year Cash flow 10.00% PV at discounted
1 762080 0.9091 692800
2 762296 0.8264 629997
3 762366 0.7513 572777
4 762292 0.6830 520656
5 762073 0.6209 473188
Total cash 2889417
Cash outflow 2250000
Net present value 639417
Interpretation: The above table is signifying net present value of Project Wolf of worth
$639417. In other way, organisation has capability to pay its net present value in each year over
5 years.
Internal rate of return: It is replicated as discount rate which makes NPV of specific
project as zero. In simple words, this return is on expected rate which would be gained on
particular investment or project. For the calculation of IRR, expected cash flow of any
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investment or project are stated at initial level and NPV is equalised to zero. In the similar
aspect, beginning period of initial cash investment must be equal to present value of investment's
future cash flow. Along with identification of IRR, it is directly compared to cost of capital of
business entity (Dhavale and Sarkis, 2018).
The projects had been undertaken for increasing revenue or for cutting cost. There is
huge requirement for investing in innovative business idea for developing new products for
accomplishing its objectives. Mostly, it is used for analysing investments for purpose of venture
capital and private equity as well. It has involvement of multiple cash investments over business
life and cash flow at year ending with sale of business (Sirinanda and et.al., 2018).
Project Aspire
Year Cash inflows
0 -2250000
1 579000
2 616542
3 656911
4 700318
5 746994
Internal rate of return (IRR) 13.62%
Interpretation: The above table is representing Internal rate of return of project. Aspire as
its cost of capital is 10% but its IRR is articulated as 13.62%. By comparing it from
organization's hurdle rate company must undertake this project as main objective is to ensure for
optimum utilisation of cash.
Project Wolf
Year Cash inflows
0 -2250000
1 762080
2 762296
3 762366
4 762292
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5 762073
Internal rate of return (IRR) 20.59%
Interpretation: The above table is extracting internal rate of return from its cash flows of
Project Wolf. In the similar aspect, its cost of capital is 10% as on its contrary, this project is
giving 20.59% which is higher than hurdle rate so it is accepted.
Payback Period: It is method which reflects duration for undertaking business for
recouping its cost of initial investment. Generally, it allows organization for comparing
opportunities related to alternative investment and to frame decision about return in short
duration (Delgado and et.al., 2018).
It is similar to analysis of break-even rather than number of units for recovering fixed
cost as it considers required time for getting return on investment. It is initially used if there is
absence of technical knowledge. This is easiest and concise method for extracting duration of
recovering initial amount of investment. It has presence of different consideration which must be
accounted for process of capital budgeting.
Project Aspire
Computation of Payback period
Year Cash inflows Cumulative cash inflows
1 579000 579000
2 616542 1195542
3 656911 1852453
4 700318 2552771
5 746994 3299766
Initial investment 2250000
Payback period 3
0.6
Payback period 3 year and 6 months
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Interpretation: The above table represents payback period of Project aspire in which its
initial investment is of 2250000. It has also considered time value of money factor for getting
outcome. In 3 years, it was covering $1852453 which is close to initial investment and rest
amount is recovered in 6 months. Hence, payback period of project Aspire is of 3 years and 6
months.
Project Wolf
Computation of Payback period
Year Cash inflows Cumulative cash inflows
1 762080 762080
2 762296 1524376
3 762366 2286742
4 762292 3049034
5 762073 3811107
Initial investment 2250000
Payback period 2
0.95
Payback period 2.95
Interpretation: The above table is representing payback period of Project Wolf with
presence of initial investment of $2250000. In 2nd year it was covering almost amount as of
1524376 and rest amount in a month. By considering aggregate, its whole initial investment is
fully recovered in approx. 3 years or of 2.95 year.
QUESTION 2
1. Recommendation for undertaking project
Parameters Project Aspire Project wolf Better
Net present value $221601 $639417 Project Wolf
Internal rate of return 13.62% 20.59% Project Wolf
Payback period 3.6 years 2.95 years Project Wolf
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Recommendation: With the above analysis, it had been recommended that AYR Co.
must undertake Project Wolf because considering each specified investment appraisal technique,
it is giving better outcome as compared to Project Aspire. In the similar aspect, it must not fully
reliable on financial factors but must consider non-financial as well along with disadvantages of
these techniques. Hence, analysing it through financial technique Project Wolf is suggested to
AYR Co. because of high returns in specified 5 years.
2. Justification for recommendation for evaluating investment appraisal techniques
Investment appraisal is considered as process of planning which is used for identifying
long term investments of organization like new products, machinery, replacement of machine
and projects for research development worth for funding cash via capitalisation structure of
organization (Bader, Al-Nawaiseh and Nawaiseh, 2018).
Justification: The above analysis is providing comparison among both with
consideration of three investment appraisal techniques such as Net present value, Internal rate of
return and payback Period. In this present scenario, every individual is rational and goal oriented
with context of money. Both projects are compared on basis of life of 5 years with initial
investment of 2.25 million. By considering net present value, Project Wolf is giving outcome of
$639417 which is higher than Project Aspire by $417816. Hence, project Wolf should be
accepted on basis of net Present value.
In the same series, it has stated internal rate of return of Project Aspire and Wolf. The
cost of capital is 10% and on this basis both projects could be accepted because both are more
than this rate. But by comparing, project Wolf is giving 20.59% which is higher than Project
Aspire as of 13.69%.
Further, it is very important for every organization to cover its initial cost of investment.
It is always said that lower is better and technically, cost must be covered as soon as possible. If
Project Aspire is selected then it would be having capability to recover its initial investment in 3
years and 6 months but on the contrary, Project Wolf has recovered in 2.95 years which is more
preferable. Hence, Project Wolf is acceptable on basis of Payback Period.
Generally, NPV fails for considering timings of cash flow difficulty might be faced for
identifying appropriate cost of capital. Further, uncertainty and risk factor is avoided in this
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method. Last criteria are about payback period, with avioding time factor and fact that some
projects have high payback period but provides high return.
In a nutshell, by considering each parameter Project Wolf is undertaken with significant
terms of value for AYR Co.
3. Summary of other factors for taking final decision
The factors for selecting project which is appropriate fit from skills, competence for
attaining success in its first step for effective project management. On basis of each scenario,
business entity has numerous option of project contracts. In this context, it has project Aspire and
Project Wolf with initial investment of 2.25 million. The organization must not handle all project
at similar duration because of resource constraints so there is huge requirement for taking
decision about selecting project which maximises profit.
There are non-financial factors for decision making about selecting projects for
accomplishing requirements of future and current legislation. It must match industry standards
and good practice. In the similar aspect, staff morale must be improved which are easier for
retention of employees. Generally, each business is engaged with risk along with probability of
hope with non-happening of outcome. Every investment has to attain return which directly
compensates risk. Generally, every project has assumptions related to pricing, demand, cost etc.
which are inaccurate by changing economic and market condition. This is considered as one of
the major issue for huge investments. The business responsibility towards other external
stakeholders and society is considered (Investment Appraisal, 2018).
The project has high risk with context to revenue estimation, costs and cash flows which
are unrealistic when project's length is high. An investment which implies substantial proportion
with availability of business funds is riskier as compared to small project. Generally, risk is
related to consequences when business has presence of wrong activity. The decision about
investment is not only about numbers but management must also consider major qualitative
issues like impact on employees, consistency of decision regarding investment related to
corporate objectives. Product quality, customer service, brand and image along with reputation
also influences investment appraisal. In the same series, it has signified different implication in
context to operation and production with involvement of disruption and changes in existing set
up.
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In this series, all methods are categorised in two forms such as Benefit measurement and
constrained Optimization models. The models of benefit measurement include NPV, Payback
period and Internal rate of return. In constrained optimization model, all non-financial factors are
associated with overall objectives of business entity. The main factor is linked to strategy of
organization for selecting project which have impact on choice or organization about its choice.
In the present scenario, there is huge necessity in this business for building cordial customer and
effective relationships. It must also consider rate of return on investment for final decision
making.
QUESTION 3
1. Description of debt and equity
Total Capital ($million) Percentage
Equity Holder Funds 20 52.63%
Long term debt 18 47.37%
38 100.00%
Debt: It is amount of money borrowed. Generally, debt is implied by various individual
and corporation as method for making huge purchases which are not directly afforded under
normal circumstances. The arrangement of debt provides permission to borrowing party to
borrow money on condition that it should be paid at later date along with interest. The loans,
auto loans, mortgage and credit card debt are referred to as important form of debt. In context of
loan, borrower has huge necessity for repaying its balance at certain date with several years in
the future. It stipulates interest amount from borrower with requirement for paying them on
yearly basis which is expressed in percentage. Generally, interest is applicable for ensuring
lender to compensate risk of loan. In the same series, borrower is encouraged to repay their loan
as quick as possible for limiting total expense of interest. In the above scenario, there is presence
of total capital of $38 million with debt of 47.37%.
Equity: It is replicated as value of asset which is less than amount of its liability. It is
referred as an ownership degree by excluding all debts linked with asset. Generally, shares are
represented as equity due to reflecting ownership in business entity and shares of public
company attain each liability. The stock or security represents interest of ownership which might
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be in private company and is linked as private equity. The particular amount of fund is
contributed in balance sheet with retained earning along with owner and shareholder. With
reference to investment strategies, equities are known as principal asset class. If in case, business
gets bankrupt and has to perform liquidate with amount of equity is remained when business has
to repay its creditors. In the above scenario, it has equity of 52.63% which is more than debt
proportion.
Debt equity ratio: It is referred as long term solvency ratio which helps in measuring
ability of business entity for repaying its obligations. The health of organization has been
examined by considering debt and equity as well. It is very difficult for paying special focus on
capital structure of organization. If there is increment in debt equity ratio which signify that it is
highly financed through creditors instead of owning its own financial resources which might be
bad indicator. The above table is signifying more equity as compared to debt (Khamidah, Gagah
and Fathoni, 2018).
2. Explanation of cost of each finance source
Working Notes for Kd and Ke
Kd: Cost of debt
Ke: Cost of equity
Ke 10.00%
Kd Ke+(1-tax rate)*inflation rate
4.50%
Kd 14.50%
Cost of debt: It is referred as a return which had been provided by organization to its
creditors and debt-holders. It is considered as effective rate of organization for repaying its
current debt. This is also replicated as cost of debt of organization before accounting taxes. The
variation among cost of debt after or before tax along with fact of deducting interests and
expenses. It contributes in capital structure of organization as it helps in measuring debt and for
understanding of overall rate which had been paid to organization with kinds of debt financing.
The investors are given idea for comparing risk level of organization from others because higher
cost of debt generally belongs to riskier business entity (Siqueira and et.al., 2018).
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Cost of equity: It is replicated as organization’s return which is mandatory for decision
about investment for accomplishing requirements of capital return. Generally, Ke is applicable
for threshold of capital budgeting at required rate of return. The cost of equity of business entity
signify compensation of market demands in exchange for asset's ownership and to bear its risk.
This concept has understanding on two aspects on individual basis or on company aspect. With
reference to individual it is required rate of return on equity's investment. Similarly, on basis of
organization it identifies required rate of return on specific investment or project.
3. Analysis of AYR Co.'s weighted Average cost of capital
Cost of capital 10.00%
Corporation tax 20.00%
Depreciation 20.00%
Total Capital ($million) Weight
Equity (10%) 20 0.52
Debt (14.50%) 18 0.47
38 1
Wacc We*Ke+Wd*Kd 7.39%
The above table is signifying rate of organization which is expected for paying average to
its major security holders for financing its assets. It is referred as cost of capital of its
organisation which is dictated through external market but not through management. The WACC
has been calculated as 7.39%.
4. Assessing impact of selection of finance on current and potential lenders and shareholders
Investors and lenders prefer low debt to equity ratio because of protecting interest with
event of business deadline. If debt equity ratio is high, then it generally shows that they are
financing in aggressive along with growth of debt. The outcome has volatile earnings along with
additional interest expense. In the same series, if huge debt is used for financing its increased
operations, the business entity generated huge earning with absence of outside financing. If
earnings are raised with great amount then interest, benefit of shareholders and lenders are
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spread among same quantity to its shareholders. The cost of debt financing might outweigh
return which had been generated through organization on debt via activities of business and
investment which becomes too much for handling by organization. It might lead to bankruptcy
and give nothing to its shareholders and lenders as well (Klasa and et.al., 2018).
CONCLUSION
From the above study it has been concluded that project's viability and decision of
programme and portfolio had been asses through investment appraisal along with generating
value. It has shown importance of various techniques along with its benefits and limitation for
selecting project. This report also states that financial and non-financial factors are important for
process of selecting project or for decision making. Further, it has been concluded that project
Wolf is giving high returns as compared to Project Aspire with parameter so getting positive
outcome in context of Net present value, Internal rate of return and payback period.
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REFERENCES
Books and Journals
Al-Mutairi, A., Naser, K. and Saeid, M., 2018. Capital budgeting practices by non-financial
companies listed on Kuwait Stock Exchange (KSE). Cogent Economics & Finance. 6(1).
p.1468232.
Bader, A., Al-Nawaiseh, H. N. and Nawaiseh, M. E., 2018. Capital Investment Appraisal
Practices of Jordan Industrial Companies: A Survey of Current Usage. International
Research Journal of Applied Finance. 9(4). pp.146-161.
Delgado, L. and et.al., 2018. Framing Energy Efficiency with Payback Period: Empirical Study
to Increase Energy Consideration during Facility Procurement Processes. Journal of
Construction Engineering and Management. 144(5). p.04018027.
Dhavale, D. G. and Sarkis, J., 2018. Stochastic internal rate of return on investments in
sustainable assets generating carbon credits. Computers & Operations Research. 89.
pp.324-336.
Khamidah, A., Gagah, E. and Fathoni, A., 2018. ANALYSIS OF THE EFFECT OF GROSS
PROFIT MARGIN (GPM), EARNING PER SHARE (EPS), DEBT TO EQUITY RATIO
(DER), NET PROFIT MARGIN (NPM) ON RETURN ON ASSETS (ROA)(Study On
Property and Real Estate Companies listed on the Indonesia Stock Exchange Year 2012–
2016). Journal of Management. 4(4).
Klasa, S., and et.al., 2018. Protection of trade secrets and capital structure decisions. Journal of
Financial Economics. 128(2). pp.266-286.
Siqueira, A. C. O., and et.al., 2018. A longitudinal comparison of capital structure between
young for-profit social and commercial enterprises. Journal of Business Venturing. 33(2).
pp.225-240.
Sirinanda, K. G., and et.al., 2018. Strategic underground mine access design to maximise the Net
Present Value. In Advances in Applied Strategic Mine Planning (pp. 607-624). Springer,
Cham.
ONLINE
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