APC 308 Financial Management Assessment: WACC, Rights Issue, & Capital

This comprehensive financial management report analyzes Kadlex plc, focusing on weighted average cost of capital (WACC) calculations, rights issues, and capital structure adjustments. The assessment explores both book value and market value approaches to WACC, evaluating the impact of capital restructuring on minimizing the cost of capital. It delves into the implications of short-termism on bankruptcy and agency problems, supported by academic research. The report also covers the calculation of the number of shares to be issued, the theoretical ex-right price, and the expected value of earnings per share. Furthermore, it evaluates project evaluation methods, comparing the benefits and limitations of various investment appraisal techniques such as payback period, accounting rate of return (ARR), net present value (NPV), and internal rate of return (IRR). The report provides detailed tables and calculations to support its findings and recommendations regarding the finance director's projections, emphasizing the importance of capital structure in financial decision-making.

APC 308 FINANCIAL
MANAGEMENT ASSESSMENT 2019

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Question 1........................................................................................................................................1
a) Calculation of Book Value and Market value cost of Capital (WACC) for Kadlex plc.........1
b) Cost of Capital of company as per the new structure of Kadlex plc......................................5
c) Minimising the cost of capital using gearing in the capital structure.....................................9
(d) Critically evaluate the effects of short-termism on bankruptcy and the agency problem in a
company, ensuring the response is supported with relevant academic research.........................9
Question 2......................................................................................................................................10
1 & 2 Number of Shares to be issued and theoretical ex right price.........................................10
3. Calculating expected value of earnings per share.................................................................11
4&5. form of an issue for price of each right issue & Presenting all the three options of the
right issue in the tabular form...................................................................................................11
©Advantage of scrip dividend for shareholders and company.................................................13
Question 3......................................................................................................................................13
(a)Project evaluation methods...................................................................................................13
(b) Critically evaluate the benefits and limitations of each of the differing investment
appraisal techniques..................................................................................................................15
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................................17
Table 1Weighted Average Cost of Capital......................................................................................1
Table 2Cost of equity.......................................................................................................................2
Table 3Cost of Preference Share Capital (Kp)................................................................................2
Table 4Cost of Debt (Kd)................................................................................................................3
Table 5Capital Structure of Kadlex as on 31 December 2017........................................................3
Table 6Total Value of Debt and Equity...........................................................................................4
Table 7Calculation of Weights........................................................................................................4
Table 8Weighted average cost of capital.........................................................................................5

Table 9Cost of Equity (Ke)..............................................................................................................5
Table 10Cost of Preference Share Capital (kp)...............................................................................6
Table 11Cost of Debt (kd)...............................................................................................................6
Table 12Capital structure.................................................................................................................7
Table 13Total Capital......................................................................................................................7
Table 14Calculation of Weights......................................................................................................8
Table 15New share issue and theoretical ex share price...............................................................10
Table 16Earning per share (EPS)..................................................................................................11
Table 17Ex- rights value per share................................................................................................11
Table 18Ex- rights value per share................................................................................................11
Table 19Ex- rights value per share................................................................................................12
Table 20Calculation of depreciation..............................................................................................13
Table 21Payback period................................................................................................................13
Table 22Calculation of ARR.........................................................................................................14
Table 23Calculation of NPV.........................................................................................................14
Table 24Calculation of IRR...........................................................................................................15

INTRODUCTION
Finance management is the one of the area which greatly impact business firm. In the
current research study detail investigation is carried out on the WACC, right issue of shares and
cost of capital. Discussion is carried out on capital restructuring that must be done in order to
reduce cost of capital in the business. At end of the report, project evaluation technique is used
and evaluation of project is done as well as viability is measured. In this way, entire research
work is carried out.
Question 1
a) Calculation of Book Value and Market value cost of Capital (WACC) for Kadlex plc.
Weighted Average Cost of Capital as per book value and Market Value.
Table 1Weighted Average Cost of Capital
Weighted Average Cost of Capital
As per Book Value
Value Weight Cost Weight*Cost
Value of Equity 20000 44.44% 53.60% 23.82%
Value of BOND 15000 33.33% 7.00% 2.33%
Value of Preference share 10000 22.22% 7.00% 1.56%
Total Capital 45000 100.00% 67.60% 27.71%
As per Market Value
Value Weight Cost Weight*Cost
Value of Equity 20000 44.44% 53.60% 23.82%
Value of BOND 15000 20.97% 7.00% 1.47%
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Value of Preference share 10000 9.80% 9.33% 0.91%
Total Capital 45000 100.00% 49.01% 25.01%
Cost of Capital
Table 2Cost of equity
Book Value
Market
Value
0 Year 1 Year
Expected dividend 0.28 0.336 0.336
Current stock price 1 2.65
Growth Rate 20.00% 20.00%
Cost of equity
= Expected Dividend
in 1 year ÷ Current
Stock Price + Growth
Rate
Cost of Equity 53.60% 32.68%
Table 3Cost of Preference Share Capital (Kp)
Cost of Preference
Capital
Book Value Market Value
Dividend per share 0.07 0.07
Net proceeds 1 0.75
Cost of Preference
Share Capital 7.00% 9.33%
2

Table 4Cost of Debt (Kd)
Cost of debt 10.00%
After tax debt (1 – 30%)
Cost of debt 7.00%
Table 5Capital Structure of Kadlex as on 31 December 2017
Capital Structure
Book Value Market Value
Current Value of Equity
Number of shares 20000 20000
Price per share 1 2.65
Value of Equity 20000 53000
Current Value of Debt
Number of Bonds 150 150
Price per bond 100 107
Value of BOND 15000 16050
Current Value of
Preference Capital
Number of Preference Shares 10000 10000
3

Price per share 1 0.75
Value of Preference share 10000 7500
Table 6Total Value of Debt and Equity
Total Value of Debt and
Equity
Book Value Market Value
Value of Equity 20000 53000
Value of BOND 15000 16050
Value of Preference share 10000 7500
Total Capital 45000 76550
Table 7Calculation of Weights
Weights
Book Value Market Value
Weight of Equity
Equity 20000 53000
Total Capital 45000 76550
Weight 44.44% 69.24%
Weight of Preference
Capital
Preference Capital 10000 7500
Total Capital 45000 76550
Weight 22.22% 9.80%
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Weight of Debt
Debt 15000 16050
Total Capital 45000 76550
Weight 33.33% 20.97%
b) Cost of Capital of company as per the new structure of Kadlex plc
Table 8Weighted average cost of capital
Weighted Average Cost of Capital
Book Value Value Weight Cost Weight*Cost
Value of Equity 57000 72.34% 31.79% 22.99%
Value of BOND 15000 19.04% 8.00% 1.52%
Value of Preference share 6800 8.63% 10.29% 0.89%
Total Capital 78800 100.00% 50.08% 25.41%
Cost of Capital
Table 9Cost of Equity (Ke)
Cost of Equity
Expected dividend 0.336
Current stock price 2.85
Growth Rate 20.00%
Cost of equity = Expected
Dividend in 1 year ÷
Current Stock Price +
Growth Rate
5

Cost of Equity 31.79%
Table 10Cost of Preference Share Capital (kp)
Cost of Preference
Capital
Dividend per share 0.07
Net proceeds after selling 0.68
Cost of Preference Share
Capital 10.29%
Cost of Debt (kd)
Table 11Cost of Debt (kd)
Cost of debt
Maturity Period 7
Par Value 100
Net
proceeds(Par+Premium) 105
I 11
Premium 5
Mp 7
I+(premium/Mp) 11.71
P 100
np 105
P+np/2 102.5
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Tax Rate (1-0.3) 0.7
Cost of Debt Capital 11.43%
After tax debt 8.00%
Capital Structure of Company of company under the proposed new plans
Table 12Capital structure
Value of Equity
Number of shares 20000
Price per share 2.85
Value of Equity 57000
Value of Debt 15000
Value of Preference
share
Number of Preference
Shares 10000
Price per share 0.68
Value of Preference
share 6800
Table 13Total Capital
Total Value of Debt and
Equity
Value of Equity 57000
7

Value of Debt 15000
Value of Preference share 6800
Total Capital 78800
Calculation of Weights
Table 14Calculation of Weights
Weight of Equity
Equity 57000
Total Capital 78800
Weight 72.34%
Weight of Preference
Capital
Preference Capital 6800
Total Capital 78800
Weight 8.63%
Weight of Debt
Debt 15000
Total Capital 78800
Weight 19.04%
Recommendations over the projections of finance director
As per given information it is clear that the finance directors intend to cut cost of capital by
issuing new debts. This will change the capital structure. It is well known fact that cost of debt is
lower than same of equity and due to this reason if debt is issued then in that case cost may
decline (Shapiro and Hanouna, 2019). The cos of debt will be increased to 11% from 10%.
Business firm will buy back its shares from the available cash amount and this will increase
share price to £2.85. It can be observed that based on new projections overall cost of capital will
be 25.41% which actually is lower than the present book value cost of capital but higher than the
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market value cost of capital. Therefore, the projections made by finance manager should be
adopted as it will increase the share value by reducing the cost of capital of company.
c) Minimising the cost of capital using gearing in the capital structure
Cost of the capital is the one of the main focal point of the most business firms. This is
because if cost of capital is high then in that case business firm have to pay more to banks and
other financial institutions. Thus, it can be said that cost of capital creates extra payment burden
on the business firm. Thus, main focus of manager always remains on reducing cost of capital in
the business. In order to reduce capital structure many business firms focus on reducing equity
and increasing debt (Finkler, Smith and Calabrese, 2018). This is known as capital restructuring.
Many times, when capital structure become imbalanced business firms restructure their capital
structure. It is well known fact that cost of debt is relatively lower then same of equity. This is
because equity shareholders are considered as real owner of the company and due to this reason
high rate is paid to them relative to interest rate on debt. Cost of debt refers to the interest that is
charged by the banks on loan amount that is taken by the firm from it. Interest paid on
debentures and corporate bond is also considered as cost of debt. Cost of debt is always lower
then cost of equity and due to this reason always it is suggested that portion of equity in the
capital structure must be low and portion of debt must be high so that cost of finance can be
controlled in the business (Renz. and Herman, 2016). However, this does not mean that firm
consistently increase bank loan or other debt instruments at fast rate in its business. This is
because many times it happened that debt burden increase in the business out of tolerable limit
and cost of debt rose sharply. Hence, firm take debt from the market only to certain level.
(d) Critically evaluate the effects of short-termism on bankruptcy and the agency problem in a
company, ensuring the response is supported with relevant academic research.
Short termism refers to the situation where firm focus on short term gain or opportunity at
the expense of the long-term opportunity of gain. Firms mainly do this when they are extremely
on pressure or competition is fierce. Many times, due to cut throat competition firms earn less
profit in their business and to ensure survival and sustainability they make efforts to earn profit
for short term. Hence, in order to earn short term profit business firm, make change in its
business operations which can be not be considered good from long term time period. If any
company is operating in mobile phone manufacturing business and face loss then it may focus on
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