Financial Management Report: Kadlex Plc and Lovewell Limited

This financial management report delves into the core principles of finance, evaluating the cost of capital, capital structure, and investment appraisal techniques. The report begins by calculating the weighted average cost of capital (WACC) for Kadlex Plc, considering both book and market values, and then recalculates it after proposed changes, analyzing the impact of gearing on the capital structure. It explores the effects of short-termism on agency problems and potential bankruptcy. Furthermore, the report assesses various investment appraisal techniques, including payback period, accounting rate of return (ARR), and net present value (NPV), to determine the viability of a new machine purchase for Lovewell Limited, offering detailed calculations and recommendations based on the findings. The report aims to provide a comprehensive understanding of financial management strategies and their practical application in business decision-making.

Financial Management

Table of Contents
INTRODUCTION...........................................................................................................................1
QUESTION 1...................................................................................................................................1
a) Cost of capital on book value and market value.....................................................................1
b. Recalculation of cost of capital of company...........................................................................4
c. Sensible level of gearing into the capital structure..................................................................5
d. Effects of short termism on agency problem and bankruptcy.................................................5
QUESTION 3...................................................................................................................................6
Investment Appraisal Techniques...............................................................................................6
b. Limitation and benefits of various investment appraisal techniques....................................10
CONCLUSION..............................................................................................................................12
REFERENCES..............................................................................................................................13

INTRODUCTION
The term of finance is backbone of any organisation and there must be a ongoing flow of
funds in and out of a business entity. Money makes the wheels of organisation run properly.
Financial management define as strategic planning, coordinating, guiding and dominating of
financial undertakings in a business entity or an institute. There are consisting of different
principles of management in which financial assets of a business, on the other hand it is playing
significant role in fiscal management. Through this management an organisation proper arrange
funds in every operational activities and allotted as per the requirement. Without this
management company can not function properly and do not proper use of funds. Along with, it is
helping in creating profit for a business entity and assuring an acceptable return on investment. It
is mainly concentrated on the future requirement of funds to conduct operational activities that
could be determined (Amanah, Rahadian and Iradianty, 2016).
To complete this project report select first and third question. In first question cover
calculation of cost of capital, changes in capital structure, minimise weighted average cos of
capital. Along with critically determination effects of short termism and bankruptcy to assure
about response. In third question analysis different investment appraisal techniques like pay back
period, net present value etc. In addition, analysis the benefits as well as limitations of each
investment appraisal techniques.
QUESTION 1
a) Cost of capital on book value and market value
The cost of capital is a cost of any organisation's funds (both debts & equity) or from an
investors view which is necessary for particular rate of return as per the portfolio of an
organisation's existing securities. This is calculated for the analysis cost of new projects of
particular organisation. In every business entities all the securities are kept in organized way that
known as capital structure. It is essential for every organisation because it supports to achieve all
the objectives like higher profitability and large number of investors etc. To calculate cost of
capital at market value and book value required to cover of all equities, debts etc. For this
purpose require to examine financial statements of Kadlex Plc have analysed of weighted
average cost of capital is lesser (Attig, Boubakri, El Ghoul and Guedhami, 2016). It is required to
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improve so director of the business issue new bonds at the market that impact on the
determination that calculated below:
For year 1 to 5 the growth are 21, 23, 25, 27 and 28 individually.
Calculation of growth=
Formula= Sn=S0*(1+g)n
28=21*(1+g)4
28/21=(1+g)4
1.33=(1+g)4
(1.33)0.25= (1+g)
g=1–1.0757
=0.0757 or 7.57%
(Here, g =growth, S0 =First dividend, n =number of years, Sn =Last dividend)
Computation of rate of growth for all the stocks is as follows:
Cost of irredeemable bonds:
Formula= Kd=[j*(1–CT)]*(Po/Pn)
Kd =[0.10*(1–0.30)]*(100/107)
=0.0654 or 6.54%
(Here, P0 =Initial Price, CT =Rate of Corporate tax rate, Kd =Cost of Irredeemable Bonds,
Pn =Current Price, j =Rate of interest on bonds)
Cost of equities:
Formula= Ke =[Sn*(1+g)+g ])/P0
Ke =[28*(1+0.075)+0.075]/2.65
=(28*1.15)/2.65
=12.15%
(Here, Sn =First dividend, P0 =Current share price of equity shares excluding dividend, Ke
=Cost of Equity, g =Growth rate, )
Cost of preference share:
Formula= Kp=(j)/Pf
= 7/75
= 0.0933 or 9.33%
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(Here, Pf =Current price of preference share excluding dividend, j =Dividend on
preference shares, Kp =Total cost of Preference Shares)
Herein calculated weighted average cost of capital in order to know market as well as book
value such as:
WACC calculations at market and book value are as follows:
WACC (Weighted average cost of capital) at market value:
Formula= [(Ke*MVe)+(Kp*MVp)+(Kd*MVd)]/Total Capital
=[(0.12*53000)+(0.09*7500)+(0.07*16050)]/76550
=[6360+675+1124]/76550
=8159/76550
= 0.1066 or 10.66%]
WACC (Weighted average cost of capital) at book value:
Formula= [(Ke*BVe)+(Kp*BVp)+(Kd*BVd)]/Total capital
=[(0.12*25000)+(0.09*10000)+(0.07*15000)]/50000
=[3000+900+1050]/50000
=4950/50000
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=0.099 or 9.9%
MVp =Market value of all the preference shares
Mvd =Market value of debts of organisation
MVe =Market value of total equities
Kp =Total cost of preference shares before making changes
Ke =Total cost of equity before making changes
Kd =Total cost of debts before applying changes
BVp =Actual book values of preference shares
Bve =Actual book value of equities
BVd =Actual book value of debts for the organisation
Total capital =book + market value of all the securities
b. Recalculation of cost of capital of company
In the context of kadlex plc, the finance director apply some modification in cost of
structure in business entity (Ferrando, Marchica and Mura, 2017). All the calculations have been
done after the changes which is beneficial for a business. There are presented all the calculations
in accurate manner such as:
Formula: [(Ke*PVe)+(Kp*PVp)+(Kd*PVd)+(Kb*PVd)]/Total capital
For all the securities proposed cost's computation is as follows:
Proposed Growth(g) ( Increased by 20%)
=0.075*1.2
=0.09 or 9%
Equities(Ke)
=[{28*(1.09)}+0.09]/2.85
=0.1074 or 10.74%
Preference shares (Kp)
=[(7/68)]
=0.1029 or 10.29%
Irredeemable Bonds (Kd)
=[10(1–0.30)]*100/107
=0.0654 or 6.54%
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New Bonds (Kd)
=[0.11(1-0.30)]*100/105
=0.0733 or 7.33%
Proposed WACC with changes =
=[(0.11*57000)+(0.10*6800)+(0.07*16050)+(0.07*15750)/95600
=(6270+680+1124+1103)/95600
=9177/95600
=0.966 or 9.66%
c. Sensible level of gearing into the capital structure
From the above computation of cost of capital of company is 10.66% but after apply the
changes by finance director reach on 9.66%. Through changes it is getting that when company
apply modification so it impact on the capital structure that will be reduced by 1% that will be
advantageous for business entity in order to save cost for potential period of time (Garcia, 2017).
As per the saving all monetary sources supports business for future expenses and growth
opportunities available in the market. An organisation wants to purchase new machinery in order
to enhance profitability as well as productivity to formulate all the functional activities in
effective way.
d. Effects of short termism on agency problem and bankruptcy
Short termism is outlined as an excessive concentrate on the entities that based on the
short term outcomes instead of long term approaches. It is effected approach because it is
focused on that place where high pressure from the investors in regard of the higher returns. As
per the changing situation enhance quarterly income and do not focus on the different approaches
that may supports to achieve positive outcomes in future period of time.
Agency problem is defined as conflict that arise in between managers and shareholders in
term of organisational activities. The management of entity can work as an agent of security
holders and liable for the execute different types of strategies that offer greater returns on
investments. When they are not liable for the agency problem so it take place and show impact
on the financial activities that related with the shareholders and don't take interest into in
activities of entity that impact on the returns of shareholders (Karadağ, 2018). While bankruptcy
can be outlined as procedure of legal activity in which a business became bankrupt because of
have not personal assets as well as property. Along with they are paying attention for short
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mechanism after that results come as agency problem and bankrupt that impact on the short term
requirements. Though, it develop condition of lack of funds for future and shareholders did not
achieve ant returns and no finance bring out operations in future. As per the condition of short
termism take place that create problem for the business entities in order to pay good returns as
per the security purpose and long term profits cannot be generated because of this (Ma, Chen and
Ampountolas, 2016).
QUESTION 3
Investment Appraisal Techniques
Investment appraisal is defined as collection of various kinds of techniques that applied
by business entity to recognise the attractiveness of an investment. The reason behind to apply
these techniques to determine the viability of particular assignment, event or portfolio decision
and the value they generate. Such as Lovewell Limited is planning to purchase new machine in
order to enhance productivity of an organisation (Ugoani, 2017). As per the reason require to
determine the benefits of organisation and apply different investment appraisal techniques. All
the details are discuss below:
Investment = £275,000
Annual Cash Inflow = £85,000
Cash Out flow = £12,500
Net Cash flow = Cash inflow – Cash outflow
= £85,000 - £12,500
= £72,500
Residual Value = 15% of the £275,000
= £41,250 added to year 6
Here is calculated total depreciation
= £275,000 - £41,250 added to year 6
= £233,750
After that calculated Annual depreciation
= £233,750/6
= £38,958.33
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Pay Back period: It is amount that needed to generate back the cost of an investment.
The payback period method mainly applied by business to determine projects or investments due
to uncovering them, through determination of related risk (Micheni, 2017). It is known as easiest
technique of an investment which is applied by most of the organisation. Through this method a
manager able to take decision about investment in new machine or not due to direct them and
analysis the time that will be found. Herein computed payback period of particular project:
Year Cash Flows Cumulative
Cash flows
0 -275000 -275,000
1 72500 -202,500
2 72500 -130,000
3 72500 -57,500
4 72500 15,000
5 72500 87,500
6 113750 201,250
Payback = (57500/72500) + 3 Years
= 3.79 Years
Recommendation: As per the computation it is analysed that the payback period is 3.79
years for new machine. It means that Lovewell limited achieve profit in 4 years. This is less than
planned target period about 6 years, thus, it is good reason to purchase new machine by
company.
The Accounting Rate of Return: It is a kind of investment appraisal techniques that is
utilised by business to analysis the annual profitability or revenues are earned by company
through investments. In general way, this method is direct to all investors to examine rate of
return that will be accomplished by them through investing in a particular project (Nicholson,
Smith, Stewart and Hoye, 2018). This method is advantageous for lovewell limited because help
to measure rate for invest into new machine and analysis increasing profits or not. There is
calculated average rate of return for new machine such as:
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Step 1
Annual Profit = Annual Net Cash flow – Annual depreciation
Residue Value £41,250 added to 6 years
Year Annual Net
Cash Flows, £
Annual
Depreciation, £ Annual Profit, £
1 72,500 38,958.33 33,541.67
2 72,500 38,958.33 33,541.67
3 72,500 38,958.33 33,541.67
4 72,500 38,958.33 33,541.67
5 72,500 38,958.33 33,541.67
6 113,750 38,958.33 74,791.67
Step 2
Average Profit = Total profit / Number of years
Total profit = 33,541.67 × 5 + £74,791.67 = £242,500.02
Average Profit = £242,500.02 / 6 = £40,416.70
Step 3
Average capital invested = (initial cost + residual value) / 2
Average capital invested = (275,000 + 41,250) /2 = £158,125
Step 4
The Accounting Rate of Return (ARR) = (average profit / average capital invested) ×100%
ARR = (40,416.70 / 158,125) × 100% = 25.56%
Recommendation: The above calculation shows that ARR project is 25.56% that means
after invested of each pounds so return will be covered a profit of approx 25%. While, ARR is
25.56% is well above the expected and minimum rate of return as compare cost of capital for
Lovewell limited is 12%. Thus, it is good investment for business to purchase new machine.
The Net present value method: This method is presented difference in between present
value of cash inflows and the cash outflows in certain period of time. For the capital budgeting
and investment planning used this method and determine the profit level for a projected
investment or project (Odebiyi, 2017). On the basis of this method company decide of invested
amount or not in particular project. For the the finance manager direct to all staff members and
measure that 275000 pounds investment is beneficial or not..
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Year Net cashflow Cost of capital 12% Present value
0 -275,000 1 -275,000
1 72,500 0.893 64,742.52
2 72,500 0.797 57,782.50
3 72,500 0.712 51,620
4 72,500 0.636 46,110
5 72,500 0.567 41,107.50
6 113,750 0.507 57,671.25
319,033.77
Net Present Values (NPV) = £319,033.75 - £275,000 = £44,033.75
Recommendations: From the above calculation through NPV method project value is
£44,033.75. There is getting positive NPV, it means through this project get expected return
which is greater than the cost of capital so it is recommended that to purchase new machine.
The Internal rate of return: It is interest rate in which net present value of all cash
flows (in positive and negative) from a project or investment same of zero. The internal rate of
return is part of investment appraisal technique that is mainly applied by an organisation to
examine awaited compound annually rate of return for proposed project (Setyawati and Suroso,
2017). In general terms, it is outlined as minimum discount rate that is utilised by manager of
Lovewell limited in order to recognise project results that may be satisfactory or not. It is
beneficial for company because it supports to machine that will be purchased to increase
profitability of an entity.
IRR = R1 +
IRR = 12% +
Year Net cashflow Cost of capital 20% Present value
0 -275,000 1 -275,000
1 72,500 0.833 60,392.50
2 72,500 0.694 50,315.00
3 72,500 0.579 41,977.50
4 72,500 0.482 34,945.00
5 72,500 0.402 29,145.00
6 113,750 0.335 38,106.25
254,881.25
NPV2 = £254,881.25 - £275,000 = -£20,118.75
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IRR = 12 + = 12 + = 12 + 5.49 = 17.49 %
Recommendations: As per the calculation it is suggested that IRR is 17.49% for
particular project. The rate of return is above expected minimum as compare of cost of capital
for Lovewell Limited is 12%. Thus, It is economically good to purchase new machine for
business.
b. Limitation and benefits of various investment appraisal techniques
There are different types of investment appraisal techniques that could be utilised through
entity as per the reason of determining the proposed investment that will be able to get all
positive outcomes for business or not. There are applied different types of techniques in
Lovewell Limited to analysis that new machine purchase or not that supports to business and
enhance the profit margin (Sumtaky, Chandrarin and Sanusi, 2018). There are discussed benefits
of limitation of these techniques such as:
Pay Back period: There are mentioned some benefits and limitations of this technique in
brief manner such as:
 Benefits: It is simplest technique of investment appraisal that applied by the entities to
calculate pay back period. It means in how many times business get return and according
to that they are taking effective decisions. In the context of uncertainty, concentrate on
the effective technique that helps to take right decision on right time and get authentic
outcomes. As per the calculation get result of pay back period liquidity is desirable that
supports to management and assure about the decision making.
 Limitation: This method is not based on the realistic approach and it takes lot of time to
measure time period for particular project. Along with some people ignores this method
is not suitable for long term investments and provide results inaccurate manner.
Accounting rate of return: To analysis different techniques require to know each
technique of limitations and benefits in depth manner such as:
 Benefits: It is beneficial method because it provides clear view of profit margin and
compute results on the basis of cash inflows. Through this technique analysis cost
efficiency and competitiveness for several projects that would be help in take effective
decisions (Thom, 2019). It fulfil all the requirements of investors, when people get
interest into higher outcomes on invested amount in this entity.
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 Limitation: This technique application fluctuated as per the situation so it is not helpful
technique. According to this method ignore profit in that year when investors are invested
amount. Such as, organisation can take interest to measure projects in the instalments so
try to measure more than two time after that it provides right results for particular
investments.
Net Present Value: Different benefits and limitations are defined of this method in
regard of particular investment such as:
 Benefits: It is effective technique that helps to management to take right decision
because of in this method concentrate on time of value at the time of calculations of
present value. During to calculation focus on the NPV which is providing advantages in
costs and investment opportunities that focused on the particular method that makes
allowance for the timing of them (Van Deventer and De Klerk, 2016).
 Limitation: As per the this technique it is not applied in realistic way because it is
difficult to understand by management and get right outcomes. Through this method is
not analysis relative measurement of return in particular rate of return that could be
accomplished by business in regard of investment that done already. The size of projects
are same so that time not applied this technique for comparison both of them.
Internal rate of return: To analysis this method effectively require to analysis
limitations and benefits in the context of company as follows:
 Benefits: The main benefits of this method that outcomes are easily interpret and simple
to understand by management. This methods mainly based on the predication because of
rate of return take by business on assumption basis. There are mainly focusing on the
time value and analysis of profitability of particular method. Through computation get
right and reliable rate of return that will be advantageous to business in decision making
procedure.
 Limitation: When projects are compared with the another project so that time do not
apply particular technique because it is not effective technique for comparison. All the
external aspects like economic of scale are not focused in calculation at the time of
internal rate of return. Different factors like future cost, time period and size of particular
project are neglected that may lead for biased outcomes (Yang, 2017)..
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CONCLUSION
As per the above report it has been concluded that financial management is important part
of any business that helps to arrange fund and concentrated on manager to aware for all activities
and control as per the requirements. For acquire grater returns from business require to take
effective decision in context of business and must take on right time. Along with determine of
weighted average cost of capital that is essential for managers to examine book value and market
value. To apply effective approaches for effectiveness of an organisation it is critical for top
authorities in order to determine effect of the short termism and bankrupt. Additionally analysis
different types of investment appraisal techniques that help to determine which project is good of
bad for the business.
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