Financial Management Report: Equity Finance and Appraisal Techniques

This financial management report provides a comprehensive overview of key concepts in financial management. The report begins with an introduction to financial management and its importance in business, followed by an analysis of long-term finance, specifically equity finance, including the calculation of theoretical ex-right price and earnings per share. The report then delves into investment appraisal techniques, such as payback period, accounting rate of return, net present value (NPV), and internal rate of return (IRR), with detailed calculations and evaluations. Additionally, the report explores the concept of dividends, differentiating between cash and scrip dividends, and discussing their advantages for both companies and shareholders. The report concludes with a summary of findings and recommendations for financial decision-making.

FINANCIAL MANAGEMENT
ASSESSMENT

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................................3
SOLUTION 2.................................................................................................................................................3
Long term finance: Equity finance..........................................................................................................3
SOLUTION 3.................................................................................................................................................7
A) Calculation of investment appraisal techniques.................................................................................7
B) The benefits and limitation of investment appraisal techniques......................................................10
CONCLUSION.............................................................................................................................................13
REFERENCES ..............................................................................................................................................14

INTRODUCTION
Financial management are broad principles and rules of management. It deals with the proper
management of the organisation's finance and ensures effective and efficient functioning of
business. It is defines as analysing investments and money in the business which is used in
decision making. Accounting department is responsible for managing the finance of the
company. Present report is based on financial management assessment where long term finance
such as equities are explained. Further report also includes investment appraisal techniques such
as payback period, accounting rate of return, net present value and internal rate of return.
Benefits and limitations of each technique is also mentioned in the report.
SOLUTION 2
Long term finance: Equity finance
(b)
Long Term Finance
S.No £1.8 £1.60 £1.40
(I)Number of
shares to be
issued 180000/1.8 18000/1.6 180000/1.4
100000 Shares 412500 Shares 428750 Shares
(ii)Theoretical
ex- right price
Market value before
right issue =1.9*30000 1.9*300000 1.9*300000
570000 570000 570000
theoretical ex
right price =
market value
before right +
funds raised
by right / total
outstanding
shares 180000+570000/400000 570000+180000/412500 570000+180000/428750
1.875 1.82 1.75
(iii) Expected
earning per
share = profit Profit = 700000*20% Profit = 700000*20% Profit = 700000*20%

after tax/total
outstanding
shares
140000 140000 140000
EPS =140000/400000 140000/412500 140000/428750
0.35 0.34 0.32
(iv) Form of
issue for each
right price Direct issue Direct issue Insured issue
(v) Evaluation
company will not face
extra redundancy in this
issue as EPS is high
this option will also be
accepted by
shareholders as their
EPS is not changing at
very high rate
all shares might not be
accepted as eps has
gone down

Suggestion:
Company should issue
its right shares at £1.8
as issuing at this price
shares will not be issued
more which will protect
company from bearing
cost of underwriters for
its shares both other
options are not
beneficial as they are
reducing the eps and
increased number of
shares will reduce the
market value of shares,
evaluating above
scenarios it is suggested
that company should
issue its right at £1.8
(c) Dividend can be defined as that part of earnings of a company which is agreed to be
distributed by board of directors of company to its shareholders. It is known as reward from
company's earnings which is shared among shareholder of different class. Dividends of company
are decided and managed by its board of directors. Its approval is taken by shareholder in
meeting by voting. There are various forms of issuing dividends such as cash payments, stock
shares, property etc. in these dividends cash dividend are most commonly accepted by
shareholders. Purpose of paying dividend is to provide returns to investors on their shareholding
in company. Dividend are important as it will retain employees and its trust (Reifarth, 2019).
They are seen as growth of company, how well company is performing in market as shareholder
generally judge growth on the basis of returns they are getting on their investments. However it
is also essential for people to know that company does not distribute all of its profits to its
shareholder only agreed portion is distributed. The remaining portion of profits is retained by
company which will be used by company for its various operations and future expansion plans.
Some companies still pay dividend even when their profits are in adequate or no profits.

Companies are able to pay dividends even on inadequate dividends as they retain considerable
amount of profits for distributing dividends to shareholders(López, 2017).
Cash Dividend
Cash dividend can be defined as payments that are made by a company from its earnings
to shareholders who have invested their money in company in form of cash. Cash dividends are
also a form of dividend that are paid in cash. Cash dividends are most preferred form of dividend
the shareholders of company. Cash dividends affects the liquidity position of company as major
amount of money is to be distributed. There are situations where companies have enough
revenues but not in form of monetary terms at that time it becomes difficult for company to
distribute cash dividend to shareholder (Zelalem, 2018).
Scrip Dividend
Scrip dividend can be defined as a dividend program where company instead of giving
their shareholders cash dividend, gives them an option to receive dividend in form of equivalent
shares of company. They are also known as bonus issue or capitalization issue and it is known as
a secondary issue as existing cash reserves of company are converted to fresh shares and offerd
to existing shareholder of company or as an additional issue to existing shareholder in proportion
of their shareholding on pro-rata basis (Sweeting, 2017). Scrip dividend are becoming a trend in
modern times as companies want to use money in other operations of company by increasing
shareholding in company by providing shares to shareholders. Scrip issue is a method of creating
fresh shares that are distributed free of charge to existing shareholders of company and therefore
known as scrip dividend.
Issues are made considering existing holdings of company. Company issues for example
2 shares for every 5 shares which are currently held by shareholder. Scrips increase number of
shares without increasing value of company. In other words it can be defined that increased
number of shares reduces existing value per share of company. Shareholders are also having
right of selling new scrips to others in market. Scrips value are required to be disclosed I tax
returns like cash dividends. Scrips dividends are helping company to grow as they are able to
invest funds over more productive activities which will help company to generate mo re revenues
(Zelalem, 2018).
Advantages of Scrip dividend to company
Scrip dividends means shares rather than cash as dividends to shareholders of company.
Companies adopt scrip dividends for conserving their cash reserves. Another benefit that arise to
company by issue of scrip dividend is that they can avoid Advance Corporation Tax which they
have to pay every time they distribute dividends to shareholders. Companies issuing scrip
dividend do not have to arrange for cash for payments of dividends to shareholders that saves
their liquid funds. Company also issues scrip dividend as they help them to save their monetary
fund which they want to utilize for their future growth plans. Company is benefited by this
program as there are situations where company do not have adequate funds for payments so they
can issue shares to existing shareholders without paying cash (Ezeagba, 2017). It helps company
to preserve its monetary funds for reinvestment. More shares will help company to reduce its

gearing ratio that will increase borrowing capacity of company in market (Johal, Roberts and
Sim, 2019).
Advantages of scrip dividend to shareholders
Scrip dividends are given as options to shareholders. Shareholders always prefer options
for making choices. Options give the investors chances to make right choice. Different
shareholders have different requirements and needs related to dividends. Scrip dividend are
mostly chosen by young and new investors as they have motive of increasing their holdings in
company so that they can get benefit from price appreciation. Scrip dividend allows shareholder
to get benefits without actually paying for shares (Iheduru and Okoro, 2018). Shareholders in
long run will get benefits from shares as the company will rise its operations and business that
will ultimately benefit shareholders as there share price will be increased over time. Shareholders
can sell shares in market at rates existing at that time and shareholder will be getting for shares
for which they have not paid. Investors will mostly choose scrip dividend as they would not be
required to pay transaction cost for shares they receive where they wold be required to pay if
those shares were brought by investors from market. Another advantage of scrip dividend to
shareholder is that they do not have to pay commissions, brokerage or stamp duty for purchasing
shares of company (Cannavan and Gray, 2017).
SOLUTION 3
A) Calculation of investment appraisal techniques
Calculation of Payback period
Payback period : The pay back period of the company is calculated to estimate the time
required to recover the cost of investment in the company. The shorter pay back period refers to
more interesting investment because company is able to recover the cost in shorter period of time
which present its efficiency and effectiveness. It can be calculated by average method and
subtraction method (How to calculate the payback period. 2019). The average method for
calculating pay back period is suitable when the cash flow are steady in the following years. It
can be calculated by adding all the cash inflow and divided it to the initial investment or cost of
the machinery. It help the finance and account manager to identify that whether they have to go
with the project or not. Here the pay back period is 1.96 year which indicate that Happy Meal
limited company cover the initial investment within 2 year which is quite good for them.
Year Cash inflows Cumulative cash inflows
1 105000 105000
2 105000 210000

3 105000 315000
4 105000 420000
5 105000 525000
6 105000 630000
Initial investment 320000
Payback period 1.96
Calculation of average rate of return
ARR : It also known as accounting rate of return which is mainly used in capital
budgeting. It refers to the return generated from the net income of the capital investment. It can
be calculated by dividing the average return from the investment to the average initial investment
(Stone and et.al., 2015). It is mainly used by the organisation to calculate the average return
generated by the multiple projects and determine that which project provides the best result. Here
the average rate of return of Happy Meal limited company is 60% which indicate that they are
able to generate profit by purchasing the machine.
Year Cash inflows
1 105000
2 105000
3 105000
4 105000
5 105000
6 105000
Average profit or cash inflow 105000
Average initial investment 176000
average initial investment [(initial investment + scrap
value) / 2] (320000+32000) / 2
ARR 60.00%

Calculation of Net present value
NPV : It help the company to identify the difference between the net present value of
cash inflow and outflow over a specific period of time. It is mainly calculated to analyse and
interpret the profitability of the project and determine that investor has to invest the project or
not. If the NPV of the project is positive than the organisation have to go with the project but if
the NPV is negative than they have to stop the project (Boardman and et.al., 2017). It help the
organisation to determine the value of the project in particular accounting period. Here the NPV
of the machine is positive so the Happy Meal limited company has to purchase the machine.
Year Cash inflows PV factor @ 12%
Discounted
cash inflows
1 105000 0.893 93750
2 105000 0.797 83705
3 105000 0.712 74737
4 105000 0.636 66729
5 105000 0.567 59580
6 105000 0.51 53196
Total discounted cash inflow 378502
Initial investment 320000
NPV (Total discounted cash
inflows - initial investment) 58502
Calculation of Internal rate of return
IRR : The internal rate of return method is mainly used in capital budgeting to estimate
or identify the profit generated from the investment. It help the company to estimate its future
growth and expansion so they can generate higher profit and product. The higher internal rate of
return is more desirable by the company (Bhuller, Mogstad and Salvanes, 2017). It can be used

by company for the multiple purpose like it can help to rank the project on the basis of its
performance. The internal rate of return of Happy Meal limited company is 24% which indicate
that by purchasing the machine company can generate higher profit. So they have to purchase the
machine for the organisation.
Year Cash inflows
0 -320000
1 105000
2 105000
3 105000
4 105000
5 105000
6 105000
Internal rate of return (IRR) 24%
B) The benefits and limitation of investment appraisal techniques
Payback period
Benefits
 Pay back period is easy to calculate and understand by the investor and financial manager
to estimate the time period require by company to cover the initial investment.
 It help the financial manager to prepare the plan and strategies to cover the cost and
charge depreciation according to the pay back period (Ehrhardt and Brigham, 2016).
 It is widely used by organisation because it help to estimate the risk associated with the
project or machinery. It is quite suitable for the small investment. As per the above calculation of Happy Meal limited company the payback period is 1.96
year which indicate that the company will cover the initial investment within the 2 year.
It present the sound position of company.
Limitation

 The payback period is calculate on the current value which ignores the time value of
money. It can be possible that the payback period of 2 project is similar but the cash flow
generated from the project may be different. So it does not provide the accurate
information to invest in which project.
 A shorter payback period does not implies the profitability of the project because it may
be possible that in end of the period the cash flow is decline due to certain drastic change
(Schaltegger and Burritt, 2017).
 In the above calculation Average method is used to calculate the payback period but it
does not appropriate when the cash flow is different in life of the assets. So the
subtraction method is much more suitable for the company.
Average rate of return
Benefits
 ARR method help the company to ascertain the profitability. In the above case the ARR of Happy
Meal limited company is 60% which indicate good position of company in market and also
suggest that they have to purchase the machine at the cost of £320000.
 It is easy to calculate and understand by different users and stakeholders to take the decision of
investment (Brigham and et.al., 2016). It help to compare the different projects and machinery cost to evaluate the profitability of each
project.
Limitation
 like the Payback period method it also ignore the time value of money which affect the
decision of top management or owner.
 ARR only consider internal factor which affect the profitability but the external factor
also affect the profitability of the project.
 It does not applicable when the investment in the project is done in instalment or several
parts.
Internal rate of return
Benefits

 The IRR method does not require the hurdle rate to calculate the return and easy to
calculate.
 As per the above case the IRR is 24% which is higher to it cost of capital 12%. It present
that by purchasing the machine Happy Meal limited company is able to generate higher
return. It also include the time value of money which help to present the accurate information
regarding the financial position of company.
Limitation
 The biggest disadvantage of the IRR method is that it does not consider the size of the
project. It is difficult to compare the two project on the basis of IRR with different time
period (Pandey, 2015).
 The IRR method ignores the future cost and only focus on the projected cash flow which
is generated by capital injection.
Net present value
Benefits
 The NPV method includes the time value of money which indicate true and accurate
position of the company.
 As per the above method the NPV of machinery is positive £58502. The positive NPV
present that Happy Meal limited company has to purchase the machinery.
 It help the company to estimate the profitability and make the decision of investment in
the project that whether they have to purchase the machinery or not. It also help to
estimate the risk associated with the project (Kieso, Weygandt and Warfield, 2016). It is used to compare the project and identify that which project is more suitable for the
organisation.
Limitation

 The disadvantage of the Net present value is that it is based on the estimation of cost of
capital and any wrong estimation affect the whole project.
 It does not involve the opportunity cost while making the investment by the Happy Meal
limited company.
 It does not provide the accurate position of the company that whether they generate
profit or loss in particular time period. It require IRR method to identify the profit
percentage by the company.
CONCLUSION
The report summarize the impact of cost of capital and capital structure of the Kadlex plc
company in the 1st part. It can be concluded the revised capital structure help the company to
minimize the cost of capital and control the activity to generate higher profit. The revised cost of
capita help the finance directors to identify the changes. In the second part of the report it can be
concluded that the different methods like IRR, payback period, ARR and Net present value
method help the Happy Meal limited company to make the decision of investment in the
organisation. By using the different method it can be find that they have to purchase the
machinery because it is under the budget of the organisation and help the company to earn higher
profit in the market.

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Online
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