APC308 Financial Management: Equity Finance, Investment Appraisal

This document presents a comprehensive solution to a financial management assignment, addressing key concepts in corporate finance. The assignment delves into equity finance, specifically focusing on right issues, providing detailed calculations for different scenarios, including the determination of theoretical ex-rights price and the analysis of various right issue options. It also explores the benefits and drawbacks of scrip dividends for both companies and shareholders. Furthermore, the assignment applies various investment appraisal techniques such as Payback Period, Accounting Rate of Return (ARR), Net Present Value (NPV), and Internal Rate of Return (IRR) to evaluate the feasibility of a new machinery purchase. The solution includes all the necessary calculations and recommendations based on the results of these techniques, providing a thorough understanding of financial decision-making processes.

FINANCIAL
MANAGEMENT

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
Question 2. Long term finance: Equity finance......................................................................3
Question 3. Calculation as accordance of investment appraisal techniques..........................8
CONCLUSION..............................................................................................................................14
REFERENCES..............................................................................................................................15

INTRODUCTION
The term financial management can be defined as a form of methodology that is related
to the preparation, organization and management of financial activities (Purce, 2014). In the
aspect of businesses, it is compulsory to manage overall resources in a better way whether this is
monetary or non-monetary. For the management of financial resources, there are different types
of techniques which are implemented by companies. Moreover, all forms of business need this to
handle their financial resources, whether they are small or large. The project report is based on
various different contexts of financial management which bring out effective right issue for
business entities and stakeholders. As well as importance of scrip dividend is also mentioned.
The report covers calculation of number of shares which have been issued by Lexbel company.
In the next part of report, different methods of investment appraisal techniques are applied such
as NPV, IRR, ARR etc. to know efficiency of given project.
MAIN BODY
Question 2. Long term finance: Equity finance.
Right issue: Lexbel company decided to raise 180000 by the rights issue in order to create an
extension in existing operations. Financial data is listed below:
Current
market
price
Right issue price £1.90 £1.80 £1.60 £1.40
Funds to be issued £180,000 £180,000 £180,000 £180,000
New shares to be issued
(Funds to be issued/Right issue price)
94,737 100,000 112,500 128,571
Book value of ordinary shares of
£0.50 £300,000
Numbers of shares
(Ordinary shares/price)
600,000
Current market value of the shares
(Number of shares*Current market
price) £1,140,000
Funds raised through right issus £180,000
Final value market
(Current market + Funds to be issued)
£1,320,000
Total new shares after right issue
( New shares issued+Number of
shares) 694,737 700,000 712,500 728,571

Reserves shares £400,000
Total value of the company
(Book value of shares+rezerved) £700,000
Profit after tax (PAT)
(Value of the company*20%) £140,000
Earning from new funds (20%)
(Funds to be issue*20%) £36,000
Total earnings after right issue £176,000
Theoretical ex-right price (TERP)
(Final value market/Total new shares
after right issue) 1.90 1.89 1.85 1.81
New earning per shares
(Total earning after right issue/Total
new shares aftre right issue) 0.25(25p) 0.25(25p) 0.25(25p) 0.24(24p)
Form of the issue for right issue price
{(1/New shares to be issue)*Numbers
of shares }
6.00 5.33 4.67
Issue of 1
for 6
right
shares
held
Issue of 9
for 48
right
shares
held
Issue of 3
for 14
right
shares
held
Theoretical ex-rights price - It is defined as a business entity's expected share price after a proper
issue. It is usually anticipated as a weighted average stock price of new and existing shares.
Organizations can use a new issue of the right to sell investors more shares, typically at a
reduced price (Chen, Lin and Lee, 2012). Share prices are influenced by the granting of new
rights as it increases the number of shares outstanding. Usually, the theoretical ex-rights price is
computed instantly and the first day of a public offering of rights.
The issue for each right issue price:
 For each share, the number of shares improved by the organization will be 100,000 shares
with respect to the rights issue of 1.80. As a result, the pro-rata one share will be assigned
by stockholders to current six shares.
 For each share, the number of shares improved by the organization will be 112500 shares
with respect to the rights issue of 1.60. As a result, the pro-rata nine shares will be
assigned by stockholders to current 48 shares.

 For each share, the number of shares improved by the organization will be 128571 shares
with respect to the rights issue of 1.40. As a result, the pro-rata three shares will be
assigned by stockholders to current fourteen shares.
(v) Analysis of best option among three right issues.
This can be found on the grounds of the above estimate that issue @ £ 1.8 will be
advantageous to the corporation. This is because the cost of the estimated earnings per share at
this level is greater than the other two prices.
(c) Benefits and drawbacks of scrip dividend for companies and shareholders.
Scrip dividend- This can be described as an issuer's current stock shares that are distributed
instead of dividends to stakeholders (Richard, Kirby and Chadwick, 2013). It is used in case of
issuers wanting to pay their investors in any way, but not having enough money to issue a
dividend. In fact, investors are presented with this form of dividends as an option to the cash
dividend. It is more advantageous to investors because no transactions fees are needed for this
dividend to be charged as commissions. Often regarded as an option to legal tendering is the
scrip dividend. In addition, dividends from scripts usually apply to newly created stocks as
opposed to pre-existing shares. The term scrip, in a wider sense, applies to a sort of alternative
currency that substitutes legal tender. A script is a form of debt in many cases but is typically
always another form of debt documents. Following, the critical scrip dividend research is
conducted in this way:
Benefits:
For shareholders-
 This dividend provides investors in the corporate entity with retaining power as well as
tends to increase the total value of assets. Therefore, in terms of compounding interest,
the market price of their share rises.
 The scrip dividends enable investors with far more yields and financial gain as opposed
to cash dividends as time goes by.
 Opposed to cash dividends, it is quite convenient for investors to handle scrip dividends.

 The advantage for a scrip dividend stockholders is that they can humanely boost their
equity stake in the firm without paying the commissions of the intermediary or the stamp
duty on an exchange purchase (Yu, Chan and Chou, 2015).
For company
 One of the main advantages of the scrip dividend is that it is beneficial for businesses to
save capital. It is because corporate entities are able to request this dividend to investors,
and this can contribute to wild money.
 In fact, it allows companies to minimize the risk of increasing liquidity position. This also
raises corporate market capitalization on the stock exchange by increasing the number of
investors.
 The advantage for the firm is that it doesn't need to find the funds to pay dividends and
could save tax in some conditions.
Drawbacks:
For shareholders-
 The price of this share relies on the state of the economy; if the circumstance is not
favourable, this may result in investor loss.
 Therefore, instead of getting any other option, people like to get money in exchange. This
makes it difficult for investors to pay any third party back scrip dividends.
 Apart from the above disadvantages, another major issue is that dividend payments are
taxable, meaning that stockholders are required to pay dividend tax (Ogiela, 2013).
 One major drawback in these dividend policies for scripts is that investors do not obtain
money to pay dividends taxation.
For company-
 In the situation where the stock of the business does not function well, this can be a risk
of investor loss for them. As well as the risk of market credibility decreasing.
 A scrip dividend is simply an option, not a cash dividend substitute. It requires a higher
time and cost that is not accessible to everyone.
 As firms, attention must be given to selling shares in different ways of paying the
shareholders.

Thus, these are some of the key benefits and disadvantages for stockholders and businesses of
scrip dividends. Moreover, this dividend is appropriate for businesses as compared to
stockholders because it offers them an alternative rather than paying a cash dividend.
Question 3. Calculation as accordance of investment appraisal techniques.
Investment appraisal technique - Capital budgeting is a planning method that uses
different techniques to help judgement making (Kober, Subraamanniam and Watson, 2012).
Corporate entities use these methods to determine the efficacy of different investment choices.
There are a vitally important number of strategies such as payback period, NPV, ARR, and many
more that businesses use. The aim of investment evaluation is to determine the feasibility and
quality of plan or investment decisions. In the scope of a business case, the main purpose of the
investment evaluation is to quantify benefits in order to justify the expenses. Below, various
techniques are implemented in the sense of Love-well limited company to determine the
performance of new machinery they are considering buying:
(I) Payback period: Initial investment / cash flow
Initial investment = 275000
Cash flow = Inflow- outflow
= 85000-12500
= 72500
Hence payback period = 275000/72500
= 3.79 years.
Suggestion - Based on the above figure, it can be found that the payback period is 3.79 years,
which means that the above company will reimburse the system costs at the end of the fourth
year. While the life of machinery is of 6 years and its cost will be recovered before the end of the
4th year. Thus, purchasing of this machinery can be beneficial for the above company.
(ii) Accounting rate of return: Average net profit / average investment *100
Cash inflow £85,000
Cash outflow £12,500
Net cash flow
(Cash inflow – Cash outflow) £75,500

Step 1
Year £ Net cash flows
£ Residual
value £ Depreciation
Annual
profit
1 72,500 0 38,958.33 33,541.67
2 72,500 0 38,958.33 33,541.67
3 72,500 0 38,958.33 33,541.67
4 72,500 0 38,958.33 33,541.67
5 72,500 0 38,958.33 33,541.67
6(Cash flows + residual
value –year depreciation) 72,500 41,250 38,958.33 74,791.67
Step 2
Average profit = (year 1+…+year 6 profit) / numbers of years
£242,500.02 / 6 = £ 40,416.67
Step 3
Average capital = (initial cost + residual value) / 2 = (£275,000 + £41,250) / 2= £158,125
Step 4
ARR= Step2 / Step3 * 100% = £40,416.67 / £158,125 *100% = 25.56 % profitability
Suggestion - Based on the rate of return measured above, this can be found that ARR is 12.19 per
cent. If above Love-well company acquires this machine, it will be good for the company to
receive a 25.56 per cent return in 6 years. So they should make a purchase of new machinery
because of the higher rate of return.
Working Note*
Depreciation = Cost of assets – Scrap value / Life of machinery
Particulars Amount
Cost of machine 275000

Less- Scrap value (15% of the cost of the
machine)
41250
233750
Hence, depreciation = 233750 / 6
= 33958.33
(iii) Net present value = Value of discounted cash flow – initial investment
Years
NPV=
Discounted
cash flow –
initial
investment
Initial
investment= 275000
Net Cash
flow
PV factor @
12%
Discounted
cash flow
Year 1 72500 0.893 64742.5
Year 2 72500 0.797 57782.5
Year 3 72500 0.712 51620
Year 4 72500 0.636 46110
Year 5 72500 0.567 41107.5
Year 6 72500 0.507 36757.5
Scarp Value 41250 0.507 20913.75
Discounted Cash Flow 319033.75
Net Present value (NPV) = 319033.75 - 275000

= 44033.75
Recommendation- Based on the above estimate, it may be suggested to procurement the machine
from the above company. This is because the machine's NPV is in positive benefit of £44033.75
The acquisition of equipment will, therefore, be useful as a means of awarding net present value.
In the case, if NPV becomes lower or negative, then machinery must not be accepted.
(iv) Internal rate of return =
Lower discounted rate + NPV at lower discount rate / (NPV at lower discount rate- NPV at
higher discount rate) * Higher discount rate- lower discount rate
Increase cost of capital at 20% (R2)
Year £ Cash flows
Cost of capital (20%)
(annuity table)
£ Present value (cash
flow * cost of capital
@20% from annuity
table)
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
NPV2 -20,118.75
R1 = 12
R2 = 20
NPV1 = £44,033.75
NPV2 = -£ 20,118.75

Recommendation- As accordance with the above-calculated value of IRR, this can find out that
acquisition of machinery can be useful for the company. Such as there it is of 17.52%, which is
higher and may lead to the generation of higher revenues.
(b) Benefits and limitations of investment appraisal techniques:
Payback period- It is characterized as a form of method linked to finding the time needed to
restore the initial capital sum. Projects with smaller cash inflows in previous periods are
consistently ranked better when measured with the payback period compared to a similar project
with greater cash inflows in later periods (Sparrow, Farndale and Scullio, 2013). It is rated higher
to invest with a narrower payback period as the initial cost of the shareholder is at threat for a
shorter time. The method of payback is the measurement used only to obtain the payback period.
The payback period is measured in years and years. As a limited company in Love-well, the
payback period is 3.79 years.
Advantages- The strength is that it is easy using this methodology. It's because fewer inputs are
required to measure the time period for portfolio recovery. The payback period, like in the above
business, is determined by making basic measurements.
Disadvantage- Including the benefits, it also has some drawbacks, as this strategy disregards the
time value. As per this technique, I am relying on the generated result is challenging.
Accounting rate of return - This is used as another name in companies like the annualized return.
It is characterized as a proportion of return required in comparison with initial capital costs on a
particular investment (Persakis and Iatridis, 2015). It extracts the average sum of income from
investments to determine the return that can be estimated over the investment's lifetime. In other

words, ARR is a method for making decisions on capital budgeting. Those generally involve
circumstances where the company decides to choose whether or not make a different investment
(a plan, an expansion, etc.) based on the projected future net income compared to the price of
capital. Like the investment planned by the above company, the ARR is 12.19 per cent. This has
some advantages and drawbacks as follows:
Advantages- It is also very quick to use and straightforward, similarly to the above method.
That's because this approach only takes into account the total amount of income during the whole
proposal's economic life.
Disadvantages - It also has some disadvantages as it lacks external factors that can change the
overall productivity of businesses. In addition, under these techniques, the time period on which
profits are generated neglected completely.
Net present value - The word NPV is usually defined as the gap between PV of money inflow
and outflow for a particular time span. This is commonly used to examine project proposals in an
effective manner (Yunus, 2013). In general, NPV evaluation is a method of inherent evaluation
and used widely in finance and accounting to assess a company's value, capital protection, capital
plan, new venture, cost-cutting program, and everything involving cash flow. The NPV of the
planned equipment in the Love-well corporation is £ 22828. It has certain drawbacks and
advantages as follows:
Advantages- The most important role of the NPV method is that it helps businesses to make
decisions. This is because, by using its methodology, financial advisors can assess the
effectiveness of all kinds of projects, particularly projects with different sizes or of the same
scale. Similar as in the above Love-well company, this technique is being used in order to make
an evaluation of their proposed machinery.
Disadvantages- Just cash in and out of any plan is considered by NPV methodology. This does
not find additional costs such as capital costs and any other initial costs incurred in connection
with any specific project. As a result, this becomes difficult for businesses to make a proper
evaluation of the project or any investment appraisal. Similar to the Love-well company, this
method is applied to compute the present value of machinery by considering only in and
outflows. The rest of the costs are ignored completely.

Internal rate of return - It is characterized as a rate of interest in which all NPV free cash flow
from any project or investment equivalent to zero. Essentially, this is used to determine the
investment's usefulness. In general, the term IRR is one of the methods for capital budgeting is
the by which a project's current value is zero (Karpoff, Lee and Martin, 2014). The users call this
' internal ' since it does not take into account any external factor (such as inflation). In the
circumstance that any project's IRR increases the rate of return of a corporation, the project is
deemed attractive. On the other hand, if the IRR is lower than the expected profit, the proposal
will be refused. Similar to in the Love-well company, the value of IRR is of 15.07% that is
considered to be effective. Hence, they should take the decision of buying the machinery. For the
purpose of critical evaluation, its benefits and drawbacks are demonstrated that are as
followings :
Advantages - The advantage of this method is that the cost of capital does not need to be
predetermined. Compared to the NPV model, this method is considered more appropriate. Take
the time value of money together with it, if cash flows are even or uneven. Apart from it, IRR is
convenient to quantify metric and offers a convenient way of comparing the value of different
projects under consideration. It gives a quick view of what capital investments would provide the
largest potential cash flow to any company.
Disadvantages- It only relies on efficiency rather than capital spending. It also means that profits
are invested back in the IRR for the remainder of the project's life, which is not likely as well as
the downside of the internal rate of return is that the approach does not take into account key
factors such as project length, future costs, or contract volume (Mihai Yiannaki, 2012). Like in
the Love-well company, the IRR of proposed machinery is calculated by neglecting some key
factors. Hence, the produced outcome can not be used as a framework for decision making.
CONCLUSION
Focused on the above project study, it can be concluded that management is too
important for companies to make smarter use of financial sources. Two issues are resolved in the
report, based on equity funding and investment evaluation. In the measurement of Lexbel plc's
equity financing, it can be concluded that earnings per share will be greater at £1.8. Further, the
additional part of the report includes crucial scrip dividend evaluation. In the Love-well company

sense, it can be inferred that they must buy the equipment because all strategies show positive
results.

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