APC308 Financial Management Report: Investment Appraisal & Valuation

This report delves into financial management, addressing two key questions: mergers and acquisitions, and investment appraisal techniques. The first section analyzes valuation models such as price-earnings ratio, dividend valuation model, and discounted cash flow method, along with their associated problems, recommending the discounted valuation method for a company. The second section focuses on investment appraisal techniques, calculating and evaluating payback period, accounting rate of return (ARR), net present value (NPV), and internal rate of return (IRR) to aid in investment decisions. The report provides detailed calculations and critical evaluations of each method to assist managers in making strategic financial decisions, with the aim of maximizing market share and returns on investment.

Financial
Management

INTRODUCTION...........................................................................................................................1
MAIN BODY..................................................................................................................................1
QUESTION 2 - Mergers and Takeover...........................................................................................1
1. Price earnings ratio..................................................................................................................1
2. Dividend valuation model........................................................................................................2
3. Discounted cash flow method..................................................................................................3
4. Discuss the problems which associated with valuation model................................................3
Recommendation:........................................................................................................................4
QUESTION 3 – Investment appraisal techniques...........................................................................4
1. Calculate the following investment appraisal technique.........................................................4
2. Critically evaluate the benefits or limitations of different investment appraisal techniques:..9
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
Financial management concentrates on ratio analysis, equity and debt. It is valuable for fund
management, income allocation, project finance, trying to hedge and monitoring foreign
exchange and commodity cycle volatility (Anthony, 2019). It is necessary for an company to
handle its funds effectively and it is vital that the funds it acquires are spent in such a way that
the returns on the project are greater than the funding costs. This report based on two different
questions which are about mergers and acquisition and investment appraisal techniques which
are used by the managers to identified best favourable project to invest. These concepts help the
managers to make strategic decisions to invest and what actions they should implement to
maximise their market share as well.
MAIN BODY
QUESTION 2 - Mergers and Takeover
1. Price earnings ratio
This is also recognized as the P / E ratio that includes share market value of the firm.
Ratios can be used for measuring company's financial performance in order to ascertain whether
they are expected to result in increased. Stock value calculated by the profit per share (after tax)
is known as the price- to - earnings ratio. Low ratio demonstrate that share price of the
company is relatively low (Brooke, 2016). This is often used as a framework for equity
transactions. Globalization of stock markets, clear interface of growth and additionally the
importance of price-earnings ratios as metrics became appropriate.
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The above calculation shows that owners of Trojan plc have earned a stake of 27 %. In
order to achieve the several benefits by using this P/E ratio, gross profit split into outstanding
shares or deal with organizations to issue the face of deduction of costs and expenses. average
payout of the company throughout the year is £ 40.4 million and the actual outstanding deals are
147 million.
2. Dividend valuation model
Main shareholders have the right to convert equity and dividend payments to equilibrium
shareholders. Actual investors of the company are borrowers to the association. When the
company earns taxable earnings, extra profits are collected and the dividend is not earned
because the revenue is not obtained, i.e. the dividend yield on the above-mentioned securities
remains constant whilst the payout ratio on equity shares is starting to shift.
This technique is used to identify the required return throughout the existing year as a
discount factor which is equal to the benefit cost at the bid’s expense (Dwiastanti, 2017). This
technique is referred to it as the model or DDM which restricts revenue. It's being used to
calculate the cost of Aztec’s shares depending on time spans. With the current contrast, all profit
is left to its existing qualities in order to know the potential. Under it, compensation assessment
using the discounted valuation model and its calculation is below:
Dividend Discount Model Fair Value: £4.774
Expected Dividends Next Year = {Dividends per Share × (1 + Expected Growth Rate)}
= {0.13 × (1 + 0.14)}
= 0.148
Expected Growth Rate = {(1 – Dividend Payout Ratio) × Return on Equity}
= {(1 – 0.48) × 0.27}
= 0.14
Cost of Equity = Risk Free Rate + Beta × Market Risk Premium
= 0.05 + 1.1 × 0.11
= 0.171
Fair Value = {Expected Dividends Next Year / (Cost of Equity – Expected Growth Rate)}
= {0.148 / (0.171 – 0.14)}
= 4.774
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Above calculation helps in estimate the specified profit is 4.774 p per share. Share price in
the market, free buoy rate and beta rating are known to be significant work to assess the
situation. Market rate is often related to as premium or risk rate as speculation brings this extra
incentive to the risk. Free buoy rates really aren't dangerous however, as there will be no chance
of losing the interest of the company.
3. Discounted cash flow method
It could be described as a measurement of the value of potential cash flows, seeking to
convey a discounted rate which reflects the expected uncertainties in market prices. It must be
taken not to equate discounted cash flow for income every month as cash flow is tracked by links
posted from predetermined maps.
Year Net Income £’ million Discounted cash flow @ 7 %
Year 1 £ 40.40 £ 37.76
Year 2 £ 41.21 £ 35.99
Year 3 £ 42.03 £ 34.31
Year 4 £ 42.87 £ 32.71
Year 5 £ 43.73 £ 31.18
£ 171.95
With the help of above calculation, figures show that limited income with distributable
payout is 2% per annum. It was found that the entity would receive the all-out money of £ 171.95
million (present value) towards the end of 5 years.
4. Discuss the problems which associated with valuation model
There are several problems that linked with the valuation methods, so before implementing
these methods managers should identified the issues which can affect the managerial decisions.
Further discussions are as follow:
 At the time of buying securities, company can't be used to evaluate companies stock of
they does not pay dividends, irrespective of capital gains (Ehrhardt and Brigham, 2016).
Dividend Discount Model (DDM) is based on the mistaken presumption that the sole
interest of a asset is the return on capital by dividend distribution.
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 Another disadvantage is the reality that certain estimates on issues like the growth rate
and the expected cost of return are included in the price at the time of calculations.
Dividend yields significantly shift with time.
 If all the observations or calculations taken in the estimation which are somewhat in
error. It may be outcome in an expert, who calculates the valuation for the product, being
undervalued or downsized dramatically. There are several variations in Closed DDM to
solve this disadvantage. However, most of these require making new assumptions and
measurements, which, over time, are often prone to expanded errors.
 It ignores the impact of stock buybacks in respect to the return of share price to
shareholders that is very big difference. This model also ignoring stock buybacks
which represents challenge in DDM, being cautious, over share price forecasts.
Recommendation:
After observing the entire three valuation model and its calculation, it is recommended that
Aztec should follow discounted valuation method that is beneficial for Trojan Plc. In context of
the organization, every company work on their earning aspects to maximise it. Among the two
valuations model based on profit and the one is overlook the return or revenue which they can
generate by using it. In this case, discounted valuation model suggested evaluating the Trojan Plc
which provides them more benefits.
QUESTION 3 – Investment appraisal techniques
1. Calculate the following investment appraisal technique
Payback period:
It is one of the most usable methods of capital budgeting that help the organizations
ti evaluate recovery period of their investment (Greve and Man Zhang, 2017). Company gains
from short payback period which allowed regaining original investments as well as increasing
their returns. The firm's financial strategy executives will decide together on potential
acquisitions. Calculating the companies' total project risk is really necessary because
administrators choose the project that holds less risk than other projects. In addition, lower the
recovery time is acceptable or higher one is rejected when managers have multiple options, so
they can make investment decisions accordingly. Its calculation is mentioned below:
Formula:
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Payback period = Initial Outlay / Cash Inflow
= 275000 / 85000
= 3.79 years
From the above calculation it is observed that payback period of this proposal is 3.79
years which are not so bad. Lovewell Company can spend their money into this project where
they can recover their initial investment within 4 years. Decision can be change if managers
found another best alternative which has low payback period in comparison to this project.
Accounting Rate of Return (ARR):
ARR has calculated in real numbers to anticipated risk of returns on investment or selling
the business. It is one of the simplest or quickest investment assessment techniques widely used
for project planning (Hashim and Piatti-Fünfkirchen, 2018). The accumulated gains are derived
from initial expenditures. ARR is the capital budgeting method that doesn't take all cash flows
into account. The higher the consumer earnings yield is beneficial, on the other hand lower the
ARR is not more profitable. The constant reinforced outcomes on different projects and makes
the necessary management choices. Projection of 6 year ARR is calculated below. The
company's managers evaluate their choices and determine whether or not to select this plan for
further spending. Base calculations are as follows:
Formula:
Accounting rate of return = Average annual profit / Initial Outlay * 100
Year Cash inflow Cash outflow Net Cash flow Depreciation Net cash flow
Year 0 275,000 -
Year 1 85,000 (12,500) 72,500 38,958.33 33541.67
Year 2 85,000 (12,500) 72,500 38,958.33 33541.67
Year 3 85,000 (12,500) 72,500 38,958.33 33541.67
Year 4 85,000 (12,500) 72,500 38,958.33 33541.67
Year 5 85,000 (12,500) 72,500 38,958.33 33541.67
Year 6 85,000 (12,500) 72,500 38,958.33 33541.67
Accounting Rate of Return = 33541.67 / 275,000 * 100
= 12.19 %
Working notes:
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Above calculation represent that ARR of this project is 12.19% which is not bad, managers
can make their investment decisions on the basis of ARR. High the return is profitable for
organization and the other hand, lower the ARR rejected if another proposal provide more return.
Net Present Value (NPV):
It is the contrast between the current value of currency inflows for a time frame and the
present value of initial investment (Khan, 2020). The NPV is used to measure the feasibility of a
planned venture or scheme in capital budgeting and financial planning. A positive NPV indicates
that, the forecasted earnings generated by a project or investment exceeds the anticipated costs.
Expenditure with a positive NPV is considered to be beneficial and a project with a negative
NPV will lead to a net loss. This concept is forms on the basis for the NPV Rule which indicates
that positive NPV of any project is beneficial for the organization to accept and the negative one
will be rejected. Its calculation mentioned below:
Formula:
Net Present Value (NPV) = Discounted cash inflow / Initial outlay
Years Cash flow Present Value @ 15% DCF
Year 1 72,500 0.892 64670
Year 2 72,500 0.797 57782
Year 3 72,500 0.711 51547
Year 4 72,500 0.635 46037
Year 5 72,500 0.567 41107
Year 6 72,500 0.506 36685
Scrap Value 41,250 0.506 20872
Discounted Cash Flow 318,700
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NPV = Cash Inflow – Cash Outflow
= 318700 – 275000
= 43,700
It is observed from above calculation that NPV is positive for this project, so managers
accept this proposal to invest.
Internal Rate of Return (IRR):
It is one of critical method of investment appraisal technique which most businesses should
consider when determining whether their proposal is successful or not. IRR based on a
compressed time frame that sets the current value and describes cash flow for the particular
project (Mitchell and Calabrese, 2019). At the time of making final decision on feasible
expenditure, it is necessary to recognize business goals and evaluate their obligations using the
capital budgeting method and to take specific or appropriate actions. In making capital
investment decisions, mangers evaluate the IRR and increase sales returns that create
profitability and environmental sustainability.
By using IRR method, the company can measure the risk, as higher earnings mean greater
risk. At the other hand, poor returns pose a low risk in order to enable the company to take
actions and to develop potential strategies. Calculating IRRs is as follows:
Formula:
IRR = Lower Discounted Rate + PV of Lower Discounted Rate – Initial investment / PV of High
Discounted Rate – PV of LDR (HDR – LDR)
Present value @ 12%
Years Cash flow PV at 12% DCF
1 72,500 0.892 64,670
2 72,500 0.797 57,782
3 72,500 0.711 51,547
4 72,500 0.635 46,037
5 72,500 0.567 41,107
6 72,500 0.506 36,685
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Scrap value 41,250 0.506 20,872
Total Present value @ 12% 318,700
Years Cash inflow PV factor @ 20% Discounted value
1 72,500 0.833 60,392
2 72,500 0.694 50,315
3 72,500 0.579 41,977
4 72,500 0.482 34,945
5 72,500 0.402 29,145
6 72,500 0.335 24,287
Scrap value 41,250 0.335 13,818
Total Present value @ 20% 254,880
Recommendation: The overall NPV of the project of Lovewell Company is 43700, that is
good which means, Lovewell Corporation is get the benefits through inventing of this product.
IRR of the project is 6.56 per cent that is profitable for the organizations to invest. Invest in this
proposal helps in improving productivity as well as profitability through providing higher
returns. From the above calculations and the findings, it is suggested that Lovewell Company
should spend their money onto this project to maximise their operational efficiency as well
as effectiveness. Managers should invest in this project that is helpful for the organization.
2. Critically evaluate the benefits or limitations of different investment appraisal techniques:
Payback period:
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Benefits: Payback period is highly helpful for a business owner which may not need to
make more difficult estimates trying to take care of some factors including marketing prices and
marketing impacts (Moortgat, Annaert and Deloof, 2017). The judgment whether to
select project or not is among the most critical decision which can be made easy through
following this capital budgeting technique. Managers may pick the correct investment
distribution, with the aid of this tool. It would allow for quick response, as it would allow the
company to recover their original cost in minimum time.
Drawbacks: One of the most critical drawbacks of payback period method is that time value
does not considered it. The cash balance is assigned higher significance in the initial years of the
project than in later life. Two enterprises refer to the same payback period. But, one spending
more cash to produces more cash flow in the first three years. In later years the second fund
provides more cash flows. This example does not specifically define which initiative they are
opting to reimburse for. Managers should avoid unpleasant NPVs because they make important
decisions that do little good. The policy does not understand the investments of money and
would rely on the average period, as each investment will have the same cash flow as other
choices.
Accounting rate of return:
Benefits: ARR allows companies to make investments. Strong revenues for the company are
safe and competitive. Management assesses the ARR proposal by selecting the right one before
making final decisions. This approach acknowledges the reporting significance that executives
often consider in the implementation period.
Drawbacks: This would not allow the time valuation of assets into account. The approach to
measuring capital expenditures is also unscientific (Siminica, Motoi and Dumitru, 2017)
(Valencia-Cárdenas and Restrepo-Morales, 2016) (Waxman, 2017). Typical return expectations
do not take into consideration the cash flow of assets, which relies on both disclosing income and
actual benefits. It will also affect the different activities that need to be carried out. Within this
methodology of analysis, the effect as well as the end outcome or viability of the proposal is
ignored.
Net Present Value (NPV):
Benefits: The lot of firms use the NPV to evaluate the commitment and evaluate whether the
company is spending in this project. The positive benefit of the preferred and unfavourable NPV
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will be rejected as the client is not supported by this effort. This financial valuation approach
takes into account the time value of money and provides new prospects for companies. Managers
should make choices that are focused on the value of the NPV.
Limitations: Managers may use these methods to assess the feasibility of their projects or to
equate them with other plans, but not just because all cash flows are equal in a project. They
need to check or claim if the initial expenditure is low, since it has no valid findings. When
modified net present value, determined by the decreased expense, avoids external variables such
as inflation.
Internal Rate of Return (IRR):
Benefits: IRR was being used primarily to describe the return that business received just
after investment, and to make more rational choices (Shakeel and Datta, 2020). Managerial
decisions which determine high yields but which project helps companies optimize their income
promotes the choice of its most efficient project leaders for the company.
Limitations: IRR doesn't really acknowledge economics of scale which affect efficiency. It
is determined by means of a system of effect & control which produces no accurate results.
Independent decision-taking processes are also affected. Additionally, there is no other
distinction in loans or borrowings. Similar to the decreased costs, each company has varying
returns, and investment decisions on executives are difficult.
CONCLUSION
From the above observation it has been concluded that, financial management play essential
role in the organization which help the managers to make operational decisions which maximise
the productivity as well as profitability. It further helps in increasing efficiency as well as
effectiveness after evaluating the above discussed findings. Managers select the best suitable
valuation method that is beneficial in context of the organization. On the other side, there are
several investment appraisal techniques which are used to evaluate the best proposal which helps
in selecting more favourable as well as profitable project.
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REFERENCES
Books & Journals
Anthony, M. U. G. O., 2019. Effects of merger and acquisition on financial performance: case
study of commercial banks. International Journal of Business Management and
Finance, 1(1).
Brooke, M. Z., 2016. Handbook of international financial management. Springer.
Dwiastanti, A., 2017. Analysis of financial knowledge and financial attitude on locus of control
and financial management behavior. Management and Business Review. pp.1-8.
Ehrhardt, M. C. and Brigham, E. F., 2016. Corporate finance: A focused approach. Cengage
learning.
Greve, H.R. and Man Zhang, C., 2017. Institutional logics and power sources: Merger and
acquisition decisions. Academy of Management Journal, 60(2), pp.671-694.
Hashim, A. and Piatti-Fünfkirchen, M., 2018. Lessons from reforming financial management
information systems: a review of the evidence. The World Bank
Khan, F., 2020. Does Dividend Policy Determine Stock Price Volatility?(A Case Study of
Malaysian Manufacturing Sector). Journal Global Policy and Governance, 9(1),
pp.67-78.
Mitchell, G. E. and Calabrese, T. D., 2019. Proverbs of nonprofit financial management. The
American Review of Public Administration. 49(6). pp.649-661.
Moortgat, L., Annaert, J. and Deloof, M., 2017. Investor protection, taxation and dividend
policy: long-run evidence, 1838–2012. Journal of Banking & Finance, 85, pp.113-
131.
Siminica, M., Motoi, A. G. and Dumitru, A., 2017. Financial management as component of
tactical management. Polish Journal of Management Studies, 15.
Valencia-Cárdenas, M. and Restrepo-Morales, J. A., 2016. Evaluation of financial management
using latent variables in stochastic frontier analysis. Dyna. 83(199). pp.35-40.
Waxman, K. T. ed., 2017. Financial and business management for the doctor of nursing
practice. Springer Publishing Company.
Setiawan, D., Bandi, B., Phua, L.K. and Trinugroho, I., 2016. Ownership structure and dividend
policy in Indonesia. Journal of Asia Business Studies.
Shakeel, S. and Datta, S., 2020. Role of Internal Audit in Merger and Acquisition. The
Management Accountant Journal, 55(4), pp.40-45.
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