APC308 Financial Management: Investment Appraisal and Valuation

This report provides a comprehensive analysis of investment appraisal techniques, including payback period, accounting rate of return (ARR), net present value (NPV), and internal rate of return (IRR), for Super Tasty Soup (STS) Limited. It evaluates the economic feasibility of investment proposals and discusses the impact of financial decisions, such as equity repurchase and dividend distribution. The report also examines the benefits and limitations of each investment appraisal technique. Furthermore, it delves into business valuation methods like the price-earnings ratio (PER) and discounted cash flow (DCF) for Dragon plc, highlighting their associated problems and suggesting the most suitable option for Kings plc. The analysis aims to provide insights into effective financial management and strategic decision-making.

INVESTMENT APPRAISAL
TECHNIQUES

TABLE OF CONTENT
INTRODUCTION...........................................................................................................................3
QUESTION 2..................................................................................................................................3
(a) Recommendation to economic feasibility..............................................................................3
(b) Discussing the effect of proposal on Super Tasty Limited....................................................7
(c) Evaluation of benefits and limitations of investment appraisal techniques...........................8
QUESTION- 3...............................................................................................................................10
a) Valuation through the price earning ratio method.................................................................10
b) Valuation of Dragon plc by the discounted cash flow method.............................................11
c) Dividend valuation method for assessing the value of Dragon plc.......................................12
d) Problems associated with the valuation techniques and the most suitable option for Kings
plc..............................................................................................................................................13
CONCLUSION..............................................................................................................................14
REFERENCES..............................................................................................................................15

INTRODUCTION
Financial management is all about implementing the processes and procedures in place
which assists in effectively handling and managing the financial resources of the company. In
this report, an analysis of the various investment appraisal techniques is being carried out which
helps in determining the feasibility of the investment proposal for the purpose of investment. In
addition to this, a critical discussion of the various business valuation methods is being done
which helps in determining the pros and cons of each of the method and selecting the right one.
QUESTION 2
(a) Recommendation to economic feasibility
For Super Tasty Soup (STS) Limited which is a fast food organization following are the
recommendation it its investment appraisals techniques for improving the economic feasibility.
Payback period :

The calculation of this payback period for this organization resulted in 3.08 years. This
payback period is the total amounted to time which the organization takes to generate the
revenue which is similar to the initial investment of the organization (Anabtawi, 2018). For
improving this period the organization needs to increase its total revenue. In order to do so STS
can provide the customers special offers that will influence them to purchase the product.
Accounting Rate of Return :

Accounting rate of return is the division of asset's average revenue with the initial
investment of the organization. The calculated percentage of ARR for STS has accounted to
39.22%. This shows that the return generated from the investment which has been made by the
organization without considering the time value factor. This result of ARR shows that the
organization is good however, for maintaining sustainability in the performance this organization
can focus on different marketing strategies to improve its sales which will ultimately improve the
revenue of the organization (Lima and et.al., 2017).
NPV :
Net Present Value is the evaluation of comparison between the capital projects and
financial products with the cash inflow over the time period. It utilizes the time value method for

the calculation of the present value of the asset to better understand the return which it has
generated. In this calculation the NPV has been calculated as 292931. That shows the present
value of the machinery purchased 6 years ago that includes the scrap value of that machinery.
Due to this method considering the time value of money it is also successful in explaining the
actual profit or loss which the business has suffered. With the help of this evaluation it can be
concluded that, this organization needs to increase its total income by reducing the expenditure
and increasing the total revenue. This can be done by increasing the efficiency of its resources so
that with the same effort more revenue can be generated.
Internal Rate of Return :
IRR is used for comparison between one investment from another. This is because it
helps in the identification of the discounted rate at which the NPV of the investment becomes 0.
Thus, it shows the annual rate of growth experienced by an investment of the organization in
their return. The IRR of this organization is 24.88% which is good, but considering the
competitive market for the fast food industry it needs to improve much more. For improving the
growth the organization can introduce new investments into its business for expanding it. The
organization will be able to do so by hiring of individuals which can improve operations (Batra
and Verma, 2017).
(b) Discussing the effect of proposal on Super Tasty Limited
The financial directors of the company have made a proposal which involves using the
40% of the capital which is being stated for investment to be utilized for repurchase of equity

while the remaining funds for the purpose of paying of dividend. The main objective behind this
proposal is to make the business procedures effective. Organization get counsel from the
financial director of the company for accomplishing the business goals in useful way by
considering all the significant variables. Capitalization structure ought to be planned by
organization in such a way that it can satisfy its internal along with external monetary
necessities. The utilization of 40% of 588300 which is 235320 for the purpose of repurchasing
equity and spending 60% in respect to distributing it as dividends to the shareholders.
The principle objective of the company is to boost productivity alongside investors
abundance so better standing can be acquired in market. The rise in the satisfaction of the
shareholders results into enhancing the establishments' extent of development within industry
and empowers it to gain upper hands. Other reason behind doing this is that the company would
not be required to deliver profit on the value shares it repurchased which will help it in holding
more from the profits which can be additionally used in the further growth and development
projects of the firm (When Does It Benefit a Company to Buy Back Outstanding Shares? 2021).
Additionally, it will result into making it simple for the organization in delivering profit to its
financial investors in an effective manner or at higher rate which will develop great and positive
picture before them. This is the main factor which may make this proposition adequate as it is
useful for the organization. Subsequently, this progression results into acquiring different
advantages to the business which can't be abstained from prompting, leading it to making a
satisfactory and feasible deal. In other words, this proposition will prompt adequately dealing
with the income of the business as the organization will as of now not needed to distribute profit
as dividend on certain number of its equity shares.
The appropriate segregation of capital equity shares and retained earnings for giving
profits along with carrying out the business tasks to a great extent by way of making use of the
retained earnings. There are a few elements which drives business to acknowledge and accept the
given proposal or proposition which is relied upon the monetary situation of association that it
will be profited or not. The upsides of keeping 40% equity capital is that there will be no
reimbursement prerequisites, lower risk, and so forth. STP would have the option to draw in
more financial investors by offering them reliability and trust that the organization is taking care
of the shareholder’s growth in addition to the company’s development. Usefulness and

productivity of STP will be expanded by accepting and going forward with the proposed
proposal.
(c) Evaluation of benefits and limitations of investment appraisal techniques
The investment appraisal techniques are used for the organization overall strategy and
decision of capital investment. They have their own benefits and drawbacks.
Payback period
Benefits :
 Its only useful in the certain situations like, rapid changes in technology and trying to
improve investment conditions.
 The calculation of the payback period is made for the analysation of quick return on
investment.
 It helps in understanding the growth of the company, minimization of the risk and
maximization of the liquidity.
 Another benefit of this is that it utilizes the cash flow for its calculation which makes the
calculation very simple.
Limitations :
 Its calculation ignores the return after the payback period. Due to which it gets limited to
the years which are mention in the calculation.
 It also ignores the timing of the cash flow, for the calculation of which the discounted
payback periods is used.
 It is very subjective as it does not provide any specific result to what needs to be done.
This method does explain what the ideal payback period should be. The calculation of this ignores the profitability of the project. Profitability is the most
important factor for the organization due to which it becomes very essential to be
considered (Tijjani, 2019).
Accounting Rate of Return :
Benefits :
 The accounting rate of return is very easy to calculate as it involves division of asset's
average revenue with the initial investment of the organization. This makes it also very
easy to understand.
 It shows relations with the profit which is shown in the accounts annually.

 It considers the entire life of the investment project and the profit earned.
 Due to its simplicity it is very popular among some business organization for their
evaluation.
Limitations :
 One of its biggest limitations is that it ignores the time value of money which is important
for understanding the actual return.
 As it utilizes the average of the return it ignores the timing of the profits.
 For the calculation of profit the another method is needed to be used after this, called
depreciation. There are different methods by which ARR can be calculated, nothing is fixed.
Net Present Value :
Benefits :
 One of the primary benefit is that it considers the time value of money, which is
important because the value of money changes with time.
 It is very essential for the decision-making process of the organization.
 It explains the investors to understand whether the particular investment will make profit
or loss (Thakur and Vaidya, 2021).
Limitations :
 For the calculation of the required rate of return there is no given calculation. People use
different method for its calculation. Due to this the rate of returns have different figures.
 It is limited as it use can be only made with projects with similar sizes. Project with high
difference in size is a limit to its calculation. It fails in consideration of the hidden cost which are not the part of the calculation.
Internal rate of return :
Benefits :
 This value does recognize the time value of money. Due to which it considered more
reliable.
 It takes account of the cash flows for the whole life of the investment.
 It is used for comparison of different alternative users which can potentially make easy
money.

Limitations :
 It is a little difficult concept for the people to understand.
 It is very dependent over ascertaining the correct cost of capital concept.
 It has been noticed that the interest some times adversely changes.
QUESTION- 3
a) Valuation through the price earning ratio method
Under PER, the price is identified by using the PER of the another similar company
within the same industry. It is determined by dividing market price per share (MPS) by the
Earnings per share (EPS). This method helps in knowing the interest of the investor pertaining to
investment into the company (Miciuła, Kadłubek and Stępień, 2020). The business shaving the
greater earning prospects results into having higher P/E ratio, this is because of the reason that
the company is in the position to pay off the greater return. For M&A, this method is useful in
making comparison with the ratios of the other similar companies.
Computation of valuation of the company using price earnings ratio
Particulars Formula Amount
(in £m)
Distributable earnings 42.4
Market price per share (MPS) 4.15
Earnings per share (EPS) 0.29
Numbers of shares
outstanding 147
Price earnings ratio of King
Plc (MPS/EPS)
= 4.15 /
0.29 =
14.31
EPS of the Dragon plc 0.29
Value of the shares of
Dragon (PER of Kind Plc * EPS of Dragon)
=14.31
*0.29 =
4.15
Determining the market
value Dragon plc
= Value of the shares of Dragon * Numbers
of shares outstanding
= 4.15 * 147 610.05

b) Valuation of Dragon plc by the discounted cash flow method
This method of valuation is also called as DCF in which valuation of the firm is done by
utilizing the cash flows. The free cash flow is determined and upon which, the future cash flows
are discounted using the WACC or the discounting rate. Through this, present worth of the future
cash flow is determined. This method is considered to be suitable for all types of business
organization as the objective of using this method does not change (Fazzini, 2018). Pertaining to
M&A, it helps in deriving the worth of the business by estimating future cash flow and is
considered to be very useful as it is not dependent upon the past and is also least affected by the
any external factors but it is little difficult to understand.
Computation of valuation of the company using Discounted cash flow
method
Particulars Formula Amount (in £m)
Evaluating the free cash flow
Net income (NI) 42.4
Less: Increase in working capital -
Less: Capital expenditure -
Add: Non-cash expenses -
Free cash flow (FCF) 42.4
Discounting rate or WACC 12.00%
MPS
= Free cash
flow /
Discounting
rate
= 42.4 / 12% =
353
Market value of Dragon plc
= MPS *
Number of
shares
= 353 * 147 51940

c) Dividend valuation method for assessing the value of Dragon plc
This method of valuation is based upon the assumption that the dividend will grow at
the constant rate. This method is considered right for those businesses where dividend payment
tends to rise at the fixed percentage annually. This approach is very easy to understand and to be
used in the organization which already has dividend pay-out ratios (Allee and et.al., 2020).
Through this model, comparison can also be drawn with other companies. This model requires
the usage of current profit which is paid as dividend, expected rate f return in addition to the
growth rate. There are few assumptions like steady growth rate, no internal or external factors is
accounted for and the free cash flow is given as dividend.
Dividend growth rate= Current year dividend – last year dividend / last year dividend *
100
Dividend growth rate= 0.14 – 0.12 / 0.12 * 100
Dividend growth rate= 0.02 / 0.12 * 100
Dividend growth rate= 16.67%
Year 1: The value of investments in the year 1 are:-
Current dividend / Expected rate of return on investments
= 0.14 / 1.12
= 0.125
Year 2: The value of investments in the year 2 are:-
Current dividend adjusted after growth rate / Expected rate of return ^ 2
= 0.16 / (1.12)^2
= 0.127
Constant growth rate: Constant growth value of a share of stock
= 0.16 / (0.12 – 0.167)
= -3.4
Value of share of Dragon plc
= 0.125 + 0.127 + -3.4
= -3.148
d) Problems associated with the valuation techniques and the most suitable option for Kings plc
There are several valuation techniques that can be applied by the company for
undertaking the business valuation so that the resultants can be used in the assessment of the

profitable deals. These are generally used in processing the mergers and acquisitions of the
company and to finalize the profitable deals in the company. But each and every valuation
technique has some or the other problems that are associated with it and which makes it unfit or
unsuitable for the company to use in order to value the other company whom the prior is
planning to either merge with or takeover. Some problems of the commonly followed method:-
Price earning ratio method:-
 One of the biggest problem in calculating the price earning ratio is that it shall be
evaluating on the basis of the accounting profit which may be calculated as per the
accounting provisions that are followed in the country. Apart from that it can also be
assessed that this does not account for the cash profits of the company and most of the
company's report profit without there being any cash.
 In this method the future earnings of the company are being estimated and are placed at
at-least the current level of income. But it is the fact that the business which is registered
on the stock exchange cannot have stability of the income and the market also operates
on the rumours which makes it further difficult for the business to maintain the
profitability.
 The PE/ratio is not self-sufficient for the investors to give the in-depth information about
the balance sheet and the financial position of the company. Simply the number of times does not give the understanding regarding the quality of the
earnings that are being received by the company.
Discounted cash flow method:-
 The first and the foremost problem for the company are that in this method they shall be
considering the operating cash flow that are being estimated for the insignificant future
period that can be for example 10 more years. The cash flow projections that are made by
the company can be uncertain and this shall be then the shots in the dark.
 The capital expenditure and the free cash flow projections in the company can also be
uncertain not giving the exact results. The plans of the company in the form of capital
expenditure are also not accurately followed by the business. Apart from all the assumptions and the interpretations in the forecasting method also the
most significant drawback is regarding the assuming of the discounting rate through
which the present value of the future cash flows is calculated.

Dividend valuation method: -
 One of the major drawbacks regarding the dividend valuation method of assessing the
value of the stocks of the company is that it is necessary to pay dividends to the
shareholders of the business.
 This method only takes into consideration dividend payments s a return on investment. Y
only looking at the dividend stocks would indicate that the portfolio is not having the
diversity which is needed in order to make it through the period of diversity.
 This valuation model ignores the effect of stock buyback. As the action of stock buyback
has a huge impact over the stock value when the shareholders receive the return. This
model forces the investors to make an assumption that such effects will never even takes
place in the whole history of the business.
Therefore, based on this critical analysis of the various business valuation techniques, it
can be stated that the price earning ratio is the most suitable method for the purpose of business
valuation as it is widely used and considered better as against other methods.
CONCLUSION
It can be concluded form the above that financial management has an important role or
part in the organization. It helps in effectively managing the financial resources of the
organization. Pertaining investment related decision making, there are various techniques and
methods which can be used for the purpose of knowing the financial feasibility of the investment
proposal. It involves using NPV, PBP, ARR, IRR etc. as the investment appraisal methods. Each
method has its pros and cons. In terms of business valuation as well, there are number of
valuation methods which is being used by the business as per the requirement and criteria it
matches. Out of all, price earning ratio is considered to be more favourable.

REFERENCES
Books and Journals
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Appraisal in Palestinian Corporations. Modern Applied Science. 12(6).
Batra, R. and Verma, S., 2017. Capital budgeting practices in Indian companies. IIMB
Management Review. 29(1). pp.29-44.
Coker, A.A., and et.al., 2017. FINANCIAL AND ECONOMIC APPRAISAL OF IRRIGATED
RICE ENTERPRISE: CAPITAL BUDGETING APPROACH.
Fazzini, M., 2018. Business valuation: theory and practice. Springer.
Lima, A.C., and et.al., 2017. A qualitative analysis of capital budgeting in cotton ginning
plants. Qualitative Research in Accounting & Management.
Miciuła, I., Kadłubek, M. and Stępień, P., 2020. Modern Methods of Business Valuation—Case
Study and New Concepts. Sustainability. 12(7). p.2699.
Tijjani, B., 2019. A survey of investors' share evaluation methods in Nigeria. Journal for Global
Business Advancement. 12(5). pp.670-692.
Warren, L. and Jack, L., 2018. The capital budgeting process and the energy trilemma-A
strategic conduct analysis. The British Accounting Review. 50(5). pp.481-496.
Online
Thakur, M and Vaidya, D., 2021. Advantages and disadvantages of NPV. [Online]. Available
through: <https://www.wallstreetmojo.com/advantages-and-disadvantages-of-npv/>
When Does It Benefit a Company to Buy Back Outstanding Shares? 2021. [Online]. Available
Through:< https://www.investopedia.com/ask/answers/040815/what-situations-does-
it-benefit-company-buy-back-outstanding-shares.asp>.