Explaining short and long term sources of finance for acquisition

This document explains the short and long term sources of finance for funding an acquisition. It discusses the benefits and limitations of different capital budgeting techniques for evaluating the viability of an acquisition. The document also provides a sample computation of payback period, net present value, average rate of return, and internal rate of return. References are included for further reading.

Report

Table of Contents
1.Explaining the short and the long term sources of the finance in funding an acquisition ......3
2. Evaluating several capital budgeting techniques and recommending viability of an
acquisition ..................................................................................................................................4
REFERENCES ...............................................................................................................................8

1.Explaining the short and the long term sources of the finance in funding an acquisition
Short term funding sources are as follows-
Overdraft Agreement- By entering into an overdraft agreement with bank, the financial
institution would allow business in borrowing to the certain limit without a requirement of the
discussion. The bank may ask the company for the security as the collateral and it might charge a
daily interest at the variable rate on an outstanding debt. However, this funding is been made
only when a business is having a confident in making repayment on a quick basis then overdraft
agreement is seen as valuable financing source.
Accounts receivable funding- Under this most of the banks provides for a discounting
facility where a company takes commercial bills to bank that makes payment after deducting a
small amount of fee (Abor, 2017). Thereafter, on a due date bank collects money from a
customer and it is seen as the another financing method among the small traders. The businesses
offers a large credit term that could carry on its operations without waiting for customers in
settle down their bills.
Long term sources are as follows-
Bank borrowings- Company could opt for the full-fledge longer period loan from the
bank which allows them in meeting their need of funds for acquisition of Ferry. However, it
involves payment of the interest and the company has to repay the amount borrowed after a
specified period of time.
Equity and debt financing- Through an issue of the shares and the debentures, company
could raise large funds in order to acquire Ferry. However, raising the funds by way of equity
results in dilution of an entity's shareholding and debt financing involves raising financial burden
relating to fixed rate of the interest (Chang and et.al., 2017). On the other state, equity financing
does not provides for any kind of interest obligation and the profit needs to paid only in case of
the profits generated. Moreover, debt financing does not involves any distribution of the profits
and the firm has to bear only the fixed amount of interest even in case company is earning larger
profits.
Thus, by using these sources of finance company could be able to raise large funds so
that it could acquire Ferry without any problem regarding lack of the funds.

2. Evaluating several capital budgeting techniques and recommending viability of an acquisition
Payback period- It is counted as the most simplest method which states the time taken by
a particular project in recovering or reaching to its initial outlay or initial investment (Alkaraan,
2017). Longer the payback period depicts a long time is been taken by the proposal in covering
its initial cost. However, shorter period reflected as better and suitable project as it covers the
initial investment cost within a short period of time.
Benefits Limitation
The payback period provides for an emphasis
on the liquidity of the proposal.
It does not considers cash inflows that is
earned after a payback period.
An entity could have more and more
favourable short run measures on the earning
per share through setting up the shorter period
of payback.
It is not counted as an appropriate technique in
measuring profitability of the project. It is
because it does not takes into account an entire
cash inflows that are yielded by a project.
Net present value- It is the process that is chosen for computing the present value of the
cash flows of a project by making use of the cost of capital as adequate discounting rate. Positive
value of NPV indicates that the project is profitable while the negative value shows that project
will generate losses.
Benefits Limitation
It recognizes the concept of time value of the
money that helps in assessing the proposal
accurately.
This method is seen as difficult in using as it
involves time factor.
This technique is seen as constant in terms of
maximising owners' welfare.
In case the projects are having different
investment amount then it does not provide

satisfactory answers.
Accounting rate of return- It is the method that makes use of an accounting information
that is revealed in final reports for measuring profits abilities of an investment projects (Warren
and Seal, 2018). Higher the ARR, better return earned from the projects and vice versa.
Benefits Limitation
This method is simple and easy in
understanding.
It does not counts length of the project lives.
It makes use of an entire income stream in
computing an accounting rate.
It ignore the time value of money and the
profits that are occurred in the different periods
are been valued on an equal basis.
Internal rate of return- This method equates the cash inflows and the cash outflows of a
specific investment (Investment appraisal techniques, 2018). Higher the IRR, more the project is
profitable in the future periods.
Benefits Limitation
It considers all the cash flows within an entire
project life.
It may not provide for unique answers and
might yield negative return or the multiple
rates under the certain circumstances.
It satisfies a users in respect of return rate of
the capital.
It includes complicated computation of the
problems.
Computation of payback period

Year Cash inflow Cumulative cash inflow
1 50730 50730
2 65545 116275
3 83875 200150
4 75370 275520
5 98055 373575
Payback period
2 + (33725 / 83875)
= 2.4 years or 2 years and 4 months
Net present value (NPV)
Year
Cash inflow
/ EBIT
Less:
Interest EBT/ EAT
PV factors
@ 3%
Discounted cash
inflow
1 55230 4500 50730 0.971 49252.4
[phone] 0.943 61782.4
3 88375 4500 83875 0.915 76757.5
4 79870 4500 75370 0.888 66965.3
5 102555 4500 98055 0.863 84583.1
Sum of
discounted cash
inflows 339341
Less: initial
investment 150000
NPV 189341
Average rate of return (ARR)
Year EBT/ EAT
1 50730

2 65545
3 83875
4 75370
5 98055
Average EAT 74715
Average investment
(150000 + 45000) / 2
= 97500
ARR 77%
Internal rate of return (IRR)
Year Cash inflows
0 -150000
1 50730
2 65545
3 83875
4 75370
5 98055
IRR 36%
Interpretation- From the above analysis it has been interpreted that acquiring Ferry will
be considered as profitable for the company as its payback period resulted as 2.4 years which
seems to be shorter and its NPV resulted as 89341 which shows that the project is profitable.

Moreover, ARR and IRR equates to 77% and 36% that is seen as larger returns will be generated
from an acquisition in the future periods.

REFERENCES
Books and journals
Abor, J. Y., 2017. Financing Choice. In Entrepreneurial Finance for MSMEs (pp. 359-369).
Palgrave Macmillan, Cham.
Alkaraan, F., 2017. Strategic investment appraisal: multidisciplinary perspectives. Advances in
Mergers and Acquisitions. p.67.
Chang, X. S. and et.al., 2017. External Financing of Last Resort? Bank Lines of Credit as a
Source of Long-term Finance. Bank Lines of Credit as a Source of Long-Term Finance
(November 1, 2017).
Warren, L. and Seal, W., 2018. Using investment appraisal models in strategic negotiation: The
cultural political economy of electricity generation. Accounting, Organizations and
Society. 70. pp.16-32.
Online
Investment appraisal techniques. 2018. [Online]. Available
through:<http://www.yourarticlelibrary.com/financial-management/5-techniques-used-in-
capital-budgeting-with-advantages-and-limitations-financial-management/29444>