Financial Management Report: Equity Finance and Capital Budgeting

This report delves into key aspects of financial management, focusing on long-term and equity finance, and investment appraisal techniques. It begins with an introduction to financial management and its role in an organization, emphasizing fund acquisition and effective utilization for profitability. T...Read More

FINANCIAL MANAGEMENT

Introduction .....................................................................................................................................3
(b).................................................................................................................................................3
1) Number of shares & Theoretical ex-right price ......................................................................3
3) Expected earnings per share....................................................................................................3
4) Forms of issue for each of the right issue price ......................................................................3
(c) Critically evaluating the benefits of the scrip dividends to company and the shareholders . 5
(a) Calculation .............................................................................................................................6
(b) Evaluating the advantages and the disadvantages of the capital budgeting techniques.........9
CONCLUSION..............................................................................................................................12
REFERENCES..............................................................................................................................13

Introduction
Financial management is considered as the organic function of the business organization
as it relates with obtaining the physical resources for carrying out production activities and the
other operations of the business with paying the compensation to suppliers. In other words
financial management refers to the operational activity that focuses on acquisition of the funds,
effective utilization of funds for gaining larger profitability. Financial management is been
viewed as the integral part of an entire management instead of the staff that is concerned with the
raising of the funds within the operation. The present study is based on various aspects of the
financial statements that includes long term finance and the equity finance. Furthermore, it
describes the several investment appraisal tools with its benefits and the limitations.
Question 2
(b)
1) Number of shares & Theoretical ex-right price
EX-right price refers to the market price that the stock theoretically has the new right
issue (kob and Whitby, 2017). It is used by the company in order to offer more shares to the
shareholders at the discounted price.
3) Expected earnings per share
Earning per share is been computed by dividing the profits of the company with that of
the outstanding shares (Price and Williams, 2018). The resultant outcome reflect the profitability
of an enterprise. It is common for the organization to report for the earning per share which is
been adjusted for the potential dilution of the shares and the extraordinary items.
4) Forms of issue for each of the right issue price
Right issue refers to the right that is given by the company to its existing shareholders for
raising the additional capital (Mateus, Farinha and Soares, 2017). Right issue price is the price at
which the new shares are been issued is less than the market price that is prevailing in the
market. In other words, it means that the shares are issued at discount rate.
Particulars Amount (£)
Current market value of Brand (6,00,000*1.90) 11,40,000

Funds to be raised through right issue 1,800000
Final market value 13,20,000
Particulars Amount (£)
Earnings before rights issue (700000*0.2) 1,40,000
Earnings from new funds (1,80,000*0.2) 36000
Total earnings after rights issue 1,76,000
Particulars Right issue price at 1.80
Number of new shares (180000/1.80) 1,00,000
Total shares in issue (600000+100000) 7,00,000
Theoretical ex- rights price (1320000/700000) £1.89 per share
New EPS =100*(176000/700000) 25.14 price per share
Form of rights issue (600000/100000) 6, i.e 1 for shares 6
Particulars Right issue price at 1.60
Number of new shares (180000/1.60) 1,12,500
Total shares in issue (600000+112500) 7,12,500
Theoretical ex- rights price (1320000/712500) £1.85 per share
New EPS =100*(176000/712500) 24.7 price per share
Form of rights issue (600000/112500) 5.33, i.e 1 for shares 5.33

Particulars Right issue price at 1.40
Number of new shares (180000/1.40) 1,28,571
Total shares in issue (600000+128571) 7,28571
Theoretical ex- rights price (1320000/728571) £1.81 per share
New EPS =100*(176000/728571) 24.16 price per share
Form of rights issue (600000/128571) 4.67, i.e 1 for shares 4.67
Interpretation-Company should select right issue price at 1.80 because at this right share price
company is expecting the highest earning price per share. Right issue shares are having highest
ex-rights value per share after the right shares issued by the company. Company should go for
selecting the option of issuing right issue shares at 1.80.
(c) Critically evaluating the benefits of the scrip dividends to company and the shareholders
Scrip dividend referred as the program in which the companies offers the right to the
shareholders in relation to receiving the dividends in the form of the cash and the shares in the
enterprise.
Advantages to shareholders-
Shareholders are been availed with an option as the needs of the shareholders differ like
in the case of the retired investor largely opts for the option of cash dividend in order to meet
their living expenses (Almeida, Fos and Kronlund, 2016). However, the youngster and the
wealthier investors desires for owing the shares in respect of capturing the appreciation in the
future price. This option allows the shareholders to become happy as they can opt for the
dividend option that they wish.
In case the shareholders feels that the share are undervalued, choosing of the scrip
dividend is better for them as under this they do not have to pay the transaction cost which they
had to pay to the broker (Guerard Jr, Markowitz and Xu, 2015). This leads to increases in the
holding of the shareholders within the company.
Shareholders gain the benefit relating to the tax saving in case of the scrip dividend as the
dividend received will be in form of the shares instead of the cash.

Advantages to company-
Organization does not have to find the cash on a frequent basis for paying the dividend
amount under scrip dividend option and in certain conditions it results in saving the taxes.
Scrip dividend helps the company in converting its retained profits into the permanent
share capital of an entity Ciftci, Mashruwala and Weiss, 2015().
It offers the enterprise with huge amount of the cash for the purpose of the re-investment
into other profitable projects.
Increased holding of the shares reduces the gearing ratio of the company and hence
increases the borrowing capacity of an entity (Beisland and Knivsflå, 2015).
Scrip dividend issue does not dilute the price of the company''s shares which is counted
as the major benefit.
Question 3
(a) Calculation
Yea
r
Annual cash
inflow
Annual cash
outflow
Less:
depreciation
EBIT/EBT/
EAT
Add:
depreciation
Cash
inflow
1 105000 15500 64000 25500 64000 89500
2 105000 15500 51200 38300 51200 89500
3 105000 15500 40960 48540 40960 89500
4 105000 15500 32768 56732 32768 89500
5 105000 15500 26214.4 63285.6 26214.4 89500
6 105000 15500 20971.52 68528.48 20971.52 89500
i. Payback period-
Year Cash inflow Cumulative (£)
0 -320000 -320000

1 89500 -230500
2 89500 -141000
3 89500 -51500
4 89500 38000
5 89500 127500
6 121500 249000
3 years+ 51500/89500=
0.6
Payback period 3.6 years
Interpretation- From the above evaluation, it is been interpreted that the payback period
for the project is been resulted as 3.6 years which means 3 years and 6 months. This is time
which the project will be taking in order to reach the break-even point.
ii. Accounting rate of return-
Year Net cash Flow (£) Depreciation (£) Profit (£)
1 89500 -64000 25500
2 89500 -51200 38300
3 89500 -40960 48540
4 89500 -32768 56732
5 89499.6 -26214 63286
6 121500 -20971 100529
Total Profit 332887

Useful Life 6 years
Average Profit £55,481.17
Accounting rate of return= Average Profit/ Initial Investment *100
ARR = £ 55481/£ 320000*100 =17.33 %
Interpretation- From the above analysis, it been viewed that the percentage return from
the investment made by the company in the project equated to 29.64%. This clearly states that
the project is facilitating the greater returns against the cost incurred in the investment.
iii. Net present value-
Year Cash
inflow
PV factor @
12%
Amount
((£)
1 89500 0.893 79910.71
2 89500 0.797 71348.85
3 89500 0.712 63704.33
4 89500 0.636 56878.86
5 89500 0.567 50784.7
6 121500 0.507 61600.5
Sum of discounted cash
flows
384248
Less: initial investment 320000
Net Present Value 64248

Interpretation- From the above analysis it is been observed that the net present value
resulted as 64248 which is a positive value. This means that the project is highly profitable and is
the best opportunity for the organization in which the investment could provide higher returns.
iv. Internal rate of return-
Year Cash inflow
0 -320000
1 89500
2 89500
3 89500
4 89500
5 89500
6 121500
18.57%
Interpretation- From the above calculations, it is been identified that 18.57% of internal
rate of return is considered as the good rate. The greater the IRR, higher returns are expected
from the project but the risk aspect is more. This depicts the positive outcome from the potential
investments as it is counted as the discount rate which makes the NPV of each and every cash
flows from the specific project equated to zero (Walthoff‐Borm, Vanacker and Collewaert,
2018). The internal rate of return is been compared to rate of discount in order to evaluate the
selected project should be perceived or not. As the IRR in this project is greater than discount
rate, so this project is said to be good.
(b) Evaluating the advantages and the disadvantages of the capital budgeting techniques.
Net present value-
It refers to the difference in between the present value of the cash inflows and outflows. It
is been used in the capital budgeting for analyzing the profitability in respect of the investment

project (Alkaraan, 2017). Positive net present value describes that the project is profitable and
the negative net present value associated with the investment results in unprofitable outcomes.
NPV is computed by subtracting the cash outflows from the cash inflows.
Benefits-Net present value provides more importance to time value of the money factor.
At the time of making the calculation under NPV, both the cash flow values are considered that
is before and after over the time period of project. Under this technique, High priority is been
given to the profitability and the risk of the proposal. It helps in enhancing the value of the firm
in the overall market as it indicates the profitability that will be generated from the project in
which the company has made investments.
Limitations-Net present value is a difficult and time consuming method because it
requires assessment of all the cash inflows and outflows of the project. It does not facilitate
accurate results if the investment amount of the mutually exclusive proposal is not been equal.
While assessing the net present value for the project, it creates difficulty in calculating the
discount rate appropriately. At the time when the project is of an unequal life, net present value
does not provide the correct decision making.
Payback period-
It means the length of the time that is required for recovering the cost of the investment. It is
stated as the time taken by the investment for reaching to the break-even point. The desirability
of the particular investment is been directly relates to the payback period. The lesser the time of
the payback reflects that the investment made is more attractive (Mahmoud and Neale, 2016).
The concept of payback is been generally used within the financial and the capital budgeting. It
is also used for determining cost savings from the technology that is energy efficient.
Benefits- This method is easy to use and simple to understand as it needs few inputs for
the calculation in comparison to the other investment appraisal technique. It helps the managers
in making quicker decisions as they could be able to calculate the payback period quickly. The
information facilitated by the payback period is crucial in comparison to other investment
appraisal methods as it focuses on ascertaining lower risk in the project. It provides the

preference to the liquidity and helps the company in recovering the cost for the purpose of
making the investment in the other growing projects. It is the most useful method in the
consequences of the uncertainty or the technological changes. This factor of the uncertainty
creates difficulty in projecting future cash flows on an annual basis. Thus, the projects that
results in shorter payback period enables in reducing possibility of the loss because of the
obsolescence.
Limitations- Payback period ignores time value of money which is been considered as
the most important concept for the business. It considers the cash flow till the recovery of the
initial investment and fails to consider cash flow in the subsequent years. It ignores the analysis
of the profitability as shorter payback does not depict that the project will generate profits
(Sangster, 1993). This results the project to unviable condition after the ending of the payback
period.
This approach is not considered as realistic in the normal course of the business as the capital
investments are not counted as the one-time investment. Instead, it needs further investment as
well in the coming years. The projects also has the irregular inflow of the cash.
Accounting rate of return-
It refers to the percentage return rate that is expected to receive on an investment or the
asset in comparison with the cost of initial investment. Accounting rate of return divides the
average revenue from the asset by enterprise initial investments in order to derive the ratio or the
return that is expected over life of the asset (Ashford, Dyson and Hodges, 1988). It does not
consider time value of the money which is an integral part for maintaining the business.
Benefits- Accounting rate of return is based on the accounting information and thus it
does need any other special reports for determining the rate of return. It is easiest to compute and
very simple in understanding. It considers total profits and the savings for the overall economic
life of project. This technique is based on the accounting profit and hence helps in measuring
profitability from the investment. It provides for the comparison of the project relating to new
product with tat of the project of reduced cost and also the other competitive nature projects.
Accounting rate of return is the budgeting method that helps in satisfying the owners interest as

they show keen interest in the investment return. It is considered as the most useful method for
measuring the present performance of an enterprise.
Limitations- It ignores time value of money concept which is essential for knowing the
accurate estimations in the future. It also ignores the cash flow generated from the investment.
Accounting rate of return method do not consider the terminal value of project. This investment
appraisal method do not consider external factors which act as the major factors that affects the
profitability of project. In the projects where the investment is to be made in parts, in such cases
this method is not suitable to apply. It does not take into account the time period of various
investments. This leads to same amount of the average and the initial investment.
Internal rate of return-
It is the metric that is used in the capital budgeting for estimating profitability of the
potential investments. It is rate of discount which makes net present value for all the cash flows
from the specific project that equates to zero (Ballantine and Stray, 1998). For assessing the
future growth and the expansion, internal rate of return is been computed.
Benefits- The foremost and the important benefit of this technique is that it considers the
tie value of the money at the time evaluating the project. It is very easy to interpret this method
after the calculation of the IRR. If the cost of capital is less than the IRR, then the project will be
accepted. This method of investment appraisal helps in evaluating the correct profit as it covers
the overall economic life of the proposal. Under this method there is not any requirement for
calculating the cost of the capital and the cut-off rate. It provides much importance towards
fulfilling the wealth maximization objective.
Limitations- Economies of the scale is the major component for every business which is
been ignored by this method. The assumption regarding the reinvestment rate is impractical as
this method assumes the positive value of the future cash flows for the remaining time period. It
indulges the finance manager for compulsorily investing into the other dependent and the
contingent projects. It includes tedious calculations. This method provides more importance to
the profitability and not considers the re coupling of the capital expenditure. Sometimes, the

results generated from the net present value technique and the IRR differs such as in case of
different size, timings and the life of the cash inflows.
CONCLUSION
From the above report it can be concluded that financial management plays an essential
role in optimum use of the company's resources which results in generating larger profits and
improves the efficiency in the operations of the business. It also helps in making the effective
financial planning which leads to safeguarding and protecting the funds. Financial management
enables the organization in allocating the funds to the investment channels that generate higher
profitability and ensure in making suitable financial decisions that leads to economic stability
and the growth. It also helps in enhancing the living standard as it contributes to financial
stability and the economic growth. Financial management includes the financial planning which
in turns results in better tax planning.

REFERENCES
Books and journals
Alkaraan, F., 2017. Strategic investment appraisal: multidisciplinary perspectives. In Advances in
Mergers and Acquisitions (pp. 67-82). Emerald Publishing Limited.
Almeida, H., Fos, V. and Kronlund, M., 2016. The real effects of share repurchases. Journal of
Financial Economics. 119(1). pp.168-185.
Ashford, R. W., Dyson, R. G. and Hodges, S. D., 1988. The capital-investment appraisal of new
technology: problems, misconceptions and research directions. Journal of the Operational
Research Society. 39(7). pp.637-642.
Ballantine, J. and Stray, S., 1998. Financial appraisal and the IS/IT investment decision making
process. Journal of Information Technology. 13(1). pp.3-14.
Beisland, L. A. and Knivsflå, K. H., 2015. Have IFRS changed how stock prices are associated
with earnings and book values? Evidence from Norway. Review of Accounting and
Finance. 14(1). pp.41-63.
Ciftci, M., Mashruwala, R. and Weiss, D., 2015. Implications of cost behavior for analysts'
earnings forecasts. Journal of Management Accounting Research. 28(1). pp.57-80.
Grobys, K. and Haga, J., 2016. The market price of credit risk and economic states. Empirical
Economics. 50(3). pp.1111-1134.
Guerard Jr, J.B., Markowitz, H. and Xu, G., 2015. Earnings forecasting in a global stock
selection model and efficient portfolio construction and management. International Journal
of Forecasting,. 31(2). pp.550-560.
Jakob, K. and Whitby, R., 2017. The impact of nominal stock price on ex-dividend price
responses. Review of Quantitative Finance and Accounting. 48(4). pp.939-953.
Mahmoud, O. and Neale, B., 2016. Managerial judgment factors and the real options approach in
the investment appraisal process: evidence from UK automotive firms. International
Journal of Business and Social Science. 7(5). pp.71-84.