Financial Management Report: Aztec plc and Trojan plc Analysis

This report delves into the realm of financial management, focusing on mergers, takeovers, and investment appraisal techniques. It begins by defining financial management and its importance in companies, emphasizing the allocation of financial resources. The main body of the report addresses two key questions: mergers and acquisitions, specifically analyzing the potential acquisition of Trojan plc by Aztec plc using methods such as Price Earnings Ratio, Dividend Valuation Model, and Discounted Cash Flow. It also provides a critical analysis of the problems associated with each valuation method and offers recommendations. The second part of the report focuses on investment appraisal methods, calculating and evaluating the efficiency of new machinery for Love well limited using the payback period, accounting rate of return, net present value, and internal rate of return. The report concludes with a critical evaluation of the benefits and drawbacks of these investment appraisal methods, providing comprehensive insights into financial decision-making.

FINANCIAL
MANAGEMENT

Contents
INTRODUCTION.....................................................................................................................................3
MAIN BODY.............................................................................................................................................3
Question 2: Merger and takeovers...........................................................................................................3
Question 3 Investment appraisal methods................................................................................................8
CONCLUSION........................................................................................................................................15
REFERENCES........................................................................................................................................16

INTRODUCTION
Financial management can be defined as a type of field in a company that is connected
with proper management of revenues, costs, return, flow of cash and many other monetary
aspects. By help of this management, it becomes easier for managers of companies to distribute
available financial resources in an appropriate manner (Chandra, 2020). The main aim of project
report is to gain knowledge about various kinds of financial concepts like dividends, investment
appraisal methods etc. In accordance of project brief, there are three questions and out of these
two questions are selected which are related to concept of merger & acquisition, investment
appraisal methods. The report covers information about theoretical and practical implication of
both mentioned concepts.
MAIN BODY
Question 2: Merger and takeovers.
Overview- This task is related to merger and takeovers in which Aztec plc is planning to acquire
Trojan plc. For this purpose, both companies’ financial information is given in order to assess
whether Aztec plc should acquire or not. In order to take suitable decision, a range of methods
has been used along with their calculations which are performed below in such manner:
(a) Price earnings ratio: Share price / Earnings per share
Given information:
Share price £2.05
Number of share outstanding 147 Million
Net income £40.4 Million
Calculation of earnings per share:
Earnings per share: Net income / Number of share outstanding
Earnings per share £40.4 Million / 147 Million
Earnings per share £0.27

Price earnings ratio:
Particulars Value
Share price £2.05
Earnings per share £0.27
Price earnings ratio £2.05 / £0.27 = 7.59
Interpretation: From above calculated value, this can be find out that price earnings ratio
is of 7.59 which is indicating that Trojan plc is generating an effective earning from their
shares. As value of their share is £2.05 on which earnings is £0.27 from each share.
(b) Dividend valuation model:
This is calculated by applying below mentioned formula:
D1 / (1 + k) + D2 / (1 + k) 2 + D3 / (1 + k) 3 + D4 / (1 + k) 4………….
Herein,
D1: Value of dividend for year one
D2: Value of dividend for year two
D3: Value of dividend for year three
D4: Value of dividend for year four
K: Expected rate of return
Given data:
D1 (Value of dividend for year one) 10p
D2 (Value of dividend for year two) 10.5p
D3 (Value of dividend for year three) 11p
D4 (Value of dividend for year four) 12p
K (Expected rate of return) 11%

Entering values in formula:
= 10p (1 + 11%) + 10.5p (1 + 11%)2 + 11p (1 + 11%)3 + 12p (1 + 11%)4
= 10 p (0.11) + 10.5p (0.11)2 + 11p (0.11)3 + 12p (0.11)4
= 11.1 + 10.5 (0.0121) + 11 (0.001331) + 12 (0.000146)
= 11.1 + 0.127 + 0.014 + 0.00175
= £11.24
Interpretation: In accordance of dividend valuation model, this can be find out that value
of share of Trojan plc is £11.24. This value of share has been calculated by help of
considering last four years’ dividend which were paid by Trojan plc.
(c) Discounted cash flow method:
Under this approach, value of share is calculated by applying such formula: CF1 / (1+r)1
+ CF2 / (1+r)2 + CF n / (1+r) n
r: 5%
= £40.4 / (1 + 5%)
= £808
Interpretation: In the discounted cash flow method, value of share is of £808. In the
calculation of share value, discounted rate is considered as 5%. As well as value of profit
is assumed as cash flow for year one that is of £40.4.
(d) Analysis of problems associated with above mentioned valuation methods.

Price earnings ratio: This ratio is also known as PER which represents relation between
company’s share prices and earnings on each share (Rahman and Shamsuddin, 2019). The
ratio is applied by companies in order to make proper valuation of share so that they can
determine whether they are over or under valued. The main objective of using this ratio is to
do analysis of stock of a company so that stock price can be assessed in an effective manner.
This is helpful for investors in order to determine market value of stock of a company in
compared to earnings. Apart from these features, this ratio has some demerits which are
explained below in such manner:
Demerits:
 One of the main drawback of this ratio is that it does not consider debt/financial
structure of a company while assessing the financial statements.
 This ratio does not provide any information about earnings per share growth of a
company. In the case when company is growing quickly then investors may make
investment though price earnings ratio is lower or higher.
 The expectation of investors can lead to inflated prices of stock for whole
industry. This is so because during recession value of shares is under evaluated in
respective to P/E ratio. One the other hands, in the inflation earnings of
companies is evaluated in accordance of currency of particular nation. It can
increase raise the value of PER (Itemgenova and Sikveland, 2020).
 This method is not suitable for those companies who are facing loss. It is so
because this model cannot assess value of losses in the initial phase of business
growth.

Dividend valuation model: It can be defined as a type of model of stock price valuation
which is based on theory that states that stock is worth the total of entire futuristic
dividend payouts. This seeks to measure a stock's fair valuation irrespective of the current
business environment, which takes into account the dividend distribution parameters
which anticipated returns on the sector (Akben-Selçuk, 2020). When the interest derived
from the DDM is greater than the current equity exchange price, then the inventory is
undervalued and applies for a buy, and vice versa. In the formula that is used under this
method value of dividend is considered for the years in which a company pays. Such as
in the context of above company, last four years’ dividend value has been used to make
proper evaluation. This method has some drawbacks which are mentioned below in such
manner-
Demerits:
 The main drawback of this method is that it can be applied only on those stock
which pay dividend. It cannot be applied on those stocks that does not pay any
kinds of dividend. In the case, when there is comparison between small and larger
companies then for small companies, this method cannot be applied.
 In the aspect of evaluating a stock, there are a range of factors which need to be
consider such as customer retention, loyalty, intangible assets etc. While in the
context of above method, these are factors are ignored because this method
considers only dividend factors (Pinto, Robinson and Stowe, 2019).
 In some nations, payment of dividend does not consider beneficial in terms of
taxation perspective. Due to which investors prefer to invest in repurchase of
stock, therefore usefulness of this model becomes null.
 The success of this method is completely based on information which is
mentioned in formula. In the case when, information is wrong the valuation of
stock will also inaccurate. So this is also a negative point for using this method of
stock valuation.

Discounted cash flow method: This is defined as a type of method in which valuation is
done in accordance of future time period’s cash flows (Shamsi, Mahdavi and Paydar,
2020). Under it, valuation of an investment is done for current time period as per the
projection of future that how much amount of fund will be generated under it. It is used
by both investors and owner of business because this contributes in an effective manner
in order to do proper evaluation. This has some drawbacks too which are as follows:
Demerits-
 This is difficult for companies to rely on the outcome which is derived by help of
this method. It is so because under this various kinds of assumptions are made
such as for discounted rate, growth rate etc.
 As well as this model is not suitable for short term investment proposals. It can be
applied only for those investing projects which are larger in size (Laitinen, 2019).
This is because implementation of this model can be expensive for short term
investments.
 This method works properly only if there is net cash flow for more than two
years, in the absence of net cash flows this method cannot be applied effectively.
Recommendation to Aztec plc: On the basis of above review of all methods of valuation
this can be guided to owners of above plc is that they should consider dividend valuation
model. It is so because under this valuation of share is done in an effective manner. On
the other side, in rest of two methods valuation of stock and earnings is done which is
suitable for internal and external stakeholders. In the case when a company wants to
acquire other company then they should apply DVM model so that proper valuation can
be carried out.

Question 3 Investment appraisal methods.
Overview: This question is related to implementation of different investment appraisal methods
in order to find out efficiency of new machinery which is proposed to purchase by Love well
limited.
1. Calculations along with recommendations:
(a) Payback period: In order to find out payback period, there are two formulas which are
applied in accordance of nature of cash flows:
When cash flows are equal: Initial investment / cash flows
When cash flows are unequal: Year before recovery of investment+ Amount to be
recovered / next years’ cash flow
In accordance of given financial data, this can be assessed that there is common cash
flow for all years, hence:
Initial investment: £275000
Cash inflow: £85000
Less: Cash outflow: £12500
Cash flow: £72500
Payback period: 275000/72500
= 3.79 years
Recommendation: from calculation of payback period of machinery, this can be find
out that cost of 275000 pounds will be recovered in 3.79 years. While life of
machinery is of 6 years so above company should purchase this machinery because
cost will be covered within life of machinery.
(b) The accounting rate of return:

Step one:
Step two:
Step three:
Step four:
Recommendation: In accordance of above calculated value of ARR, this can be find
out that new machinery will produce return with a rate of 25.56% for 6 years. The
rate of return is acceptable because with this pace of return, company will surely
cover cost of investment.
(c) Net present value:

Cost of capital: 12 % (R1)
Recommendation: On the grounds of calculated sum of net present value of new
machinery this can be find that current value of project is 44033.75 pounds. This is
indicating that purchasing of machinery will be beneficial for above company
because current value of machinery is positive and higher which is a sign of higher
return in upcoming time period for above company.
(d) Internal rate of return (IRR)

Increase cost of capital at 20% (R2)
R1 = 12
R2 = 20
NPV1 = £44,033.75
NPV2 = -£ 20,118.75