Finance Report: Investment Appraisal, Business Structures, and Ratios

This report provides an in-depth analysis of financial concepts, focusing on capital investment appraisal, business structures, working capital management, and financial ratio analysis. The report begins with an evaluation of a proposed investment project for Redstone plc, utilizing techniques such as undiscounted payback period, Weighted Average Cost of Capital (WACC), Net Present Value (NPV), and Accounting Rate of Return (ARR) to assess its viability. It then explores different business structures, specifically partnerships and limited companies, discussing their advantages and disadvantages for the owner of X store. Furthermore, the report delves into the significance of working capital management for daily business operations, highlighting its impact on return on capital, solvency, liquidity, and the overall value of the business. The report also includes a detailed calculation and analysis of key financial ratios for Media Tech plc over two years, offering insights into the company's financial health. Finally, it examines the importance of budgeting and outlines various accounting concepts to aid financial statement preparation.

Introduction to Finance

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
TASK...............................................................................................................................................1
Question 1........................................................................................................................................1
a) Calculate the undiscounted payback period.......................................................................1
b) Calculate the Weighted Average Cost of Capital (WACC)...............................................1
c) Calculate the Net Present Value (NPV) of the project, using the WACC computed above...2
d) Calculate the Accounting Rate of Return (ARR)...............................................................2
e) Critical appraisal of the project..........................................................................................3
Question 2........................................................................................................................................3
a) Outline two types of business structures owner may consider, and discuss the advantages
and disadvantages of both of it...............................................................................................3
b) Significance of working capital management in the business...........................................5
Question 3........................................................................................................................................6
(i) Calculate the twelve ratios for the company......................................................................6
(ii) Analysis of the financial health of the company..............................................................7
Question 4........................................................................................................................................8
a) Critically evaluate statement regarding budget..................................................................8
b) Explain various accounting concepts.................................................................................9
CONCLUSION..............................................................................................................................10
REFERENCES .............................................................................................................................11

INTRODUCTION
Finance is the blood of the organisation as through this, it is able to channelise funds to
most productive resources which yield better profits and more market share in the best possible
way. The enclosed report deals with Redstone plc which is planning for investment in the project
and as such, capital investment appraisal techniques are required to be carry out. Media Tech plc
accounting ratios are calculated for two years for analysing performance. For X store, various
business structures are carried so that more profits may be made by owner. Moreover, budget's
importance is also outlined and accounting concepts as well. Accounting concepts play essential
role to management and helps them to make correct and meaningful information by carrying out
the financial statements in the best possible way.
TASK
Question 1
a) Calculate the undiscounted payback period
Year Inflow Outflow net cash flow
Cumulative cash
flow
1 100000 25000 75000 75000
2 100000 25000 75000 150000
3 100000 25000 75000 225000
4 100000 25000 75000 300000
5 100000 25000 75000 375000
6 100000 25000 75000 450000
Initial investment = 340000
Payback period = 4 + 35000 / 75000
= 4.47 years
b) Calculate the Weighted Average Cost of Capital (WACC)
The formula for calculation of WACC is ad follows :
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[(Equity/Equity + Debt) x Equity return] + [(Debt/Debt + Equity) x Debt return]
The equity as well as debt financing is 170000 each. The cost of equity is 7 % and debt is 6 %
interest. Therefore, WACC is calculated as :
= 170000 / 170000 + 170000 * 7 % + 170000 / 170000 + 170000 * 6 %
= 3.50 + 3
= 6.50 %
c) Calculate the Net Present Value (NPV) of the project, using the WACC computed above.
NPV is calculated by taking risk premium rate as well. Therefore, Cost of capital = 6.5 %
+ 1.5 % = 8 % which is the discount factor to be used for calculating NPV of the investment
proposal.
NPV = Total discounted cash inflows – initial investment
Year Inflow Outflow
net cash
flow
PV factor
@ 8%
Discounted
cash
inflow
1 100000 25000 75000 0.926 69444.44 75000
2 100000 25000 75000 0.857 64300.41 150000
3 100000 25000 75000 0.794 59537.42 225000
4 100000 25000 75000 0.735 55127.24 300000
5 100000 25000 75000 0.681 51043.74 375000
6 100000 25000 75000 0.630 47262.72 450000
Total
discounted
cash inflow 346715.97
Initial
investment 340000
NPV 6715.97
NPV is positive.
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d) Calculate the Accounting Rate of Return (ARR)
Year Inflow Outflow
net cash
flow
PV factor
@ 8%
Discounted
cash inflow
1 100000 25000 75000 0.926 69444.44 75000
2 100000 25000 75000 0.857 64300.41 150000
3 100000 25000 75000 0.794 59537.42 225000
4 100000 25000 75000 0.735 55127.24 300000
5 100000 25000 75000 0.681 51043.74 375000
6 100000 25000 75000 0.630 47262.72 450000
Total
investment 600000
Average
investment 100000
ARR 29.41%
e) Critical appraisal of the project
The project should be accepted by the company. Redstone plc should be benefited by the
proposal as NPV, payback period, ARR are positive. The payback period which is considered by
the management is about 4 years. From the calculation of payback period, investment will bit
profitable as amount will recover in 4.47 years. Lower the payback period, better for the
company as investment must be profitable when amount is recovered in less time. By this
method, profit planning may be made by management and also payback time of project may be
ascertained effectually (Baños-Caballero, García-Teruel and Martínez-Solano, 2014).
Furthermore, NPV is showing positive value as the amount is 6715.97 which shows that
net present value of the project is positive and it will be profitable for the company and as such
investment should be done by Redstone organisation. It is valuable concept as it considers time
value of money which the project will recover. Higher NPV, better for the company. ARR is also
positive which is 29.41 % and also profitable for the company. It is calculated in percentage and
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as such, better and effective decisions may be taken by the company with much ease. It also lays
emphasis on assessing profit margin.
Question 2
a) Outline two types of business structures owner may consider, and discuss the advantages and
disadvantages of both of it
The business structure and advantages and disadvantages are as follows:
1. Partnership -
The owner may take the form of business structure of partnership as it is mutually
handled by more than one person or owners in the business. The partnership is a form of legal
business which is run by two or more than two owners which provides capital in the business and
as such risks are divided in the ratio made by them. The partners may be individual or
organisation as well (Bromiley, McShane and Rustambekov, 2015).
Advantages -
1. The sole trader is relaxed as losses and profits are shared in the equal ratio which is
governed by the partnership deed. This makes huge capital involved in the business and
consecutively, business is expanded. More capital is available to the business.
2. Moreover, it is easy to establish partnership firm by the mutual consent of partners
involved in the deed and government regulation is also less in this business structure.
Disadvantages -
1. The liability of the business partners are unlimited for the debt. However, it is limited
to individual's share in the business.
2. Demerit of this business structure is that partners may involve in the disagreement and
consecutively may indulge in disputes which limits use of partnership business.
2. Limited company -
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The owner of X store may involve in the limited company business structure. The limited
company means that liability of the subscriber is limited to the extent of money invested in the
business. This company may also bifurcated as company limited by shares and company limited
by guarantee. Any public or private companies may be a limited company (Fracassi, 2016). The
liability of the owners or investors is limited to extent of shares subscribed by them. They cannot
be called for paying additional amount in the event of winding up of organisation.
Advantages -
1. Limited company is useful for the investors' perspective. It is so because company
offers more protection to them. This is not possible in partnership or sole proprietorship business
structures. They are liable only to the shares purchased by them and hence, more security is
offered.
2. The company is register in the Registrar of Companies and therefore, unique name is
allotted to every company and hence, no similar name exists and customers' are not confused
about the name of the company and they remain loyal to particular brand (Kaczynski, Salmona
and Smith, 2014).
Disadvantages -
1. The directors are solely responsible for furnishing the legal documents of organisation
to Companies House and failure to do so may incur penalty charges on them and every
responsible officer.
2. The company information is provided to external users and as a result, less privacy is
maintained by it rather than sole proprietorship or partnership legal structures do not face such
demerit. Accountancy fees are required to be paid by the organisation to statutory auditors which
leads to additional cost.
b) Significance of working capital management in the business
The working capital management is useful for daily operations of the business.
Organisation need to have effective and aggressive working capital policy so that day to day
operations of the organisation is not hampered. Working capital is the difference between the
current assets and current liabilities of the company. The importance of the working capital
management in the business are as follows :
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1. High return on capital -
With effective working capital, business will provide higher return on the investment
made by the investors in the company (Importance of Working Capital Management). As such,
investors will be benefited with the help of improved working capital in the business. Moreover,
the investors will provide more funds to the organisation which will enhance better performance
of it.
2. Solvency -
The main aim of the organisation is to meet short-term liabilities and obligations within
the stipulated time. This ensures better solvency position of the company as it is able to meet
short-term liabilities with much ease. This is possible only by having effective working capital in
the organisation. As a result, credit risk is reduced up to great extent as business is able to meet
liabilities.
3. Higher liquidity -
External financing is less used by the business if more of the working capital is available
to the firm at its disposal. This makes effective utilisation of working capital of the organisation
and less reliant on loans which increases interest burden on organisation. This is beneficial for
small business as they do not have enough of the funds to get credit facilities as it increases
liability and reduces liquidity position of them (Gitman, Juchau and Flanagan, 2015).
4. Increased value of business -
More cash flows are generated by the business as effective and aggressive working
capital policy is implemented by the business. This automatically increases value of the
organisation and this results in higher valuation of the enterprise. Moreover, if the business is
engaged in manufacturing line, working capital is heavily required so that it may be able to carry
out daily business operations with much ease.
Question 3
(i) Calculate the twelve ratios for the company
Media Tech UK plc
Particulars Formula 2016 2015
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Return on Capital
Employed (ROCE) EBIT / Capital Employed 0.39 0.48
Return on shareholders’
investment (ROI)
Income after interest and tax /
Total average stockholder's
equity 62.44% 55.20%
Gross margin Gross profit / net sales * 100 7.98% 7.82%
Operating profit margin Operating profit / net sales * 100 3.72% 3.53%
Acid-test ratio Liquid assets / Current liabilities 0.2 :1 0.82 :1
Asset turnover ratio Net sales / Average total assets 1.50% 1.46%
Inventory days
365 days/ Inventory turnover
ratio 41.81 days 43.09 days
Days payables
outstanding
Ending accounts payable/ Cost
of sales / Number of days 99.71 days 91.58 days
Days receivables
outstanding
Ending accounts receivable /
Cost of sales / Number of days 65.15 days 63.41 days
Dividend yield
Dividend per share / Stock's
price per share 36.71 18
Dividend payout ratio Dividends / Net income 0.59% 0.61%
Price/Earnings ratio
Market Value per Share /
Earnings per Share 0.17% 0.32%
(ii) Analysis of the financial health of the company
1. Management perspective -
The financial health of the company is good as it has gross profit margin of 7.98 % in
2016 which is increased from 7.82 % in the past year 2015. It can be interpreted that
management of the company is successful in carrying out responsibilities and duties in effective
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way. The management's perspective may be implied that management is keen to apply the
appropriate measures so that company may be able to perform better in the market. Moreover,
management need to implement better decisions so that company may flourish in the market in
the best possible way (Purce, 2014).
The acid test ratio of Media Tech plc is gone down or decrease as it was 0.82 in the 2015
year which has come down to 0.20 % in 2016 financial year. This should be tackle effectively by
the management otherwise, organisation may not be able to meet extreme short-term liabilities
which accrue within one year.
It may be interpreted that Return on shareholders’ investment (ROI) is increased as it was
55.20 % in the financial year 2015 and in 2016 is 62.44 %. This shows that company is
effectively utilising shareholders' funds as it is generating good return on shareholders’
investment (Swanson and Frederick, 2016). On the other hand, management is required to
formulate strategies so that price earnings ratio may be increased by the company and more
subscribers' are attracted and as a result, more funds may be available to organisation to carry in
smooth operations.
2. Shareholders' perspective -
The shareholders' perspective is regarding the earnings on share subscribed by them.
Moreover, they are keen to know the amount of dividend which will be provided to them by the
company. As a result, they are required that adequate amount of dividends may be paid by the
company so that more dividends may be earned by them. The dividend payout ratio of Media
Tech plc in the financial year 2015 is 0.61 % and which is slightly reduced in 2016 year as it is
0.59 %. This means that company should be able to provide dividends to shareholders' in
adequate amount so that they may be attracted to company to acquire more shares. Moreover,
new subscribers may also be attracted to invest in the company in the best possible way (Joo and
Durri, 2015).
Coming to price earnings ratio, Media Tech plc has 0.32 % in 2015 year which is
decreased to 0.17 % in financial year 2016. It shows that company's performance is declined as
price earnings ratio has gone down. The shareholders' may not subscribe shares of the company
as organisation is not able to make good market value of price of shares in the market. The
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dividend yield ratio is however increasing as it has risen up to 36.71 % which was 18 in 2015
financial year. This shows that company is able to make effective profits and as a result,
shareholders' will be benefited by more dividends in relation to share price of company in 2016.
The financial position of the company is overall good in the market (Biswas, 2015).
Question 4
a) Critically evaluate statement regarding budget
Budget is termed as detailed monetary plan of the organisation which sets out the
estimated requirements of the various departments of the organisation in future period. Budget
may be prepared by personnels so that business may be able to effectively utilised scare
resources in the most productive way. The budget helps managers to plan, monitor and control
performance of the organisation. This is explained as follows :
1. Planning -
Budget helps business to prepare effective business plans which are required for business
to flourish by carefully analysing the requirements of the business departments. Planning is
required so that resources are fully utilised by the business and hence, proper operations of
business may be accomplished (Graham and et.al,, 2017).
2. Monitor -
Monitoring is useful as budget prepared need to be constantly monitored so that no lag
may be found in the business. This helps management to keep strict supervision on activities of
the particular department so that it may utilised budget effectively in the best possible way.
3. Control -
This is last but important stage in the budgeting process. The management prepares
budgeted output which is then compared with the actual output. This gives clear picture to the
managers as where company is lacking. As such, corrective action is taken by the management
so that such deviation may be removed with much ease. As a result, planning, monitoring and
controlling are achieved by managers which is required in the preparation of the budget.
b) Explain various accounting concepts
The accounting concepts are as follows:
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1. Money measurement concept:
This concept states that business transactions should be presented in monetary terms and
must be recorded in accounting books. The non-monetary transactions are ignored in this concept
as transactions which relates to money are to be recorded in the books of accounts.
2. Dual aspect concept:
This concept states that every transaction occurred in the business should have dual effect
such as debit and credit must be equal. Moreover, business transaction must be recorded in two
different accounts. This will automatically produce reliable information in the financial
statements which are prepared by organisation (Borio, James and Shin, 2014).
3. Accounting period concept:
Accounting period concept means that business is required to produce accounting
information in specific time period such as 6 months and 1 year. It is the time range which is
provided by the organisation and transactions are accumulated in the balance sheets and other
financial statements. It is much helpful for the investors' to compare results of various periods.
4. Business entity concept:
The concept states that business transactions must be recorded in the books of accounts
which is distinct from its owners (Cheng, Ioannou and Serafeim, 2014). This means that business
and owners are distinct and separate entity from each other. The financial information may be
produced effectively with much ease as owners are treated as separate from the business, they
run. This provides useful and correct information which is also used by external interested
parties.
CONCLUSION
Hereby it can be concluded that organisation is required to perform well in the market so
that it may be able to satisfy customers' as well as various stakeholders'. They are crucial part of
the company and as such, organisation needs to perform better. From the report, it can be
analysed that NPV, ARR is good for the Redstone company and it can make investment in the
same as it will be beneficial and profitable for the company. Furthermore, X store may use
various legal business structures to carry out business activities with much ease. Financial ratios
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