Analyzing Valuation, Diversification & Investment Appraisal

This report provides a comprehensive overview of corporate financial management, focusing on key aspects such as diversification, company valuation, and investment appraisal techniques. It begins by discussing diversification as a risk management strategy, highlighting the importance of balancing risk and return. Various valuation methods, including the Price/Earnings Ratio, Dividend Valuation Method (Gordon Growth Model), and Discounted Cash Flow (DCF) method, are analyzed with practical examples. Key drivers of these valuation methods are identified, emphasizing the influence of factors like profitability, market conditions, and cash flow projections. Furthermore, the report delves into investment appraisal techniques, evaluating their strengths and weaknesses in the context of making informed investment decisions. The analysis incorporates financial ratios and models to illustrate the concepts, offering insights into maximizing shareholder wealth through sound financial judgment and risk allocation. This student contributed assignment is available on Desklib, a platform offering a wide range of study resources for students.

Corporate Financial
Management

Contents
INTRODUCTION...........................................................................................................................................4
PART B.........................................................................................................................................................4
TASK 1..........................................................................................................................................................4
Diversification..........................................................................................................................................4
TASK 2..........................................................................................................................................................6
Valuation of company..............................................................................................................................6
Key drivers of valuation methods............................................................................................................9
TASK 3........................................................................................................................................................11
Investment appraisal techniques...........................................................................................................11
Evaluation of investment appraisal techniques.....................................................................................14
CONCLUSION.............................................................................................................................................16
REFERENCES..............................................................................................................................................17

INTRODUCTION
Financial principles are used inside a company to produce and preserve value via sound
judgment and risk allocation. Corporate finance is concerned with the capital available that
corporations offer with the main purpose of maximizing shareholders wealth. Corporate finance
is concerned with a statement of financial position, such as its financing and management's
efforts to raise the firm's worth. The techniques and analyses used to priorities and allocate
monetary capacity are also included in accounting and finance. Corporate finance is the use of
financial instruments and analytics to boost profitability, increase price, enhancing company
results, generate and deploy capital, and mitigate economic problems. The majority of corporate
finance skilled person for firms and organizations (Jiang, Li and Wang, 2021). These very same
abilities are also useful in the military, investing banks, advising, and for businessmen who are
just beginning out or expanding their firms. The first section of this paper looks at how an
investment might balance risk and profit. In the second half, many approaches for valuing a
corporation are examined. Investment appraisal methodologies are illustrated in the report's last
section for greater understanding.
PART B
TASK 1
Diversification
Diversification is a risk management strategy. To decrease the risk associated with a given
investment scheme, an investment is divided among a wide range of payment products inside a
portfolios. Other theory behind this method is that a mixture of several asset types would
produce greater lengthy profits while lowering the risk associated with a single asset, i.e., the
profits from successful investments will outweigh the costs from unsuccessful investments.
Bonds and stocks, for instance, typically conduct in opposite directions. Share prices are
anticipated to decline as the economy is struggling. Financial institutions slash borrowing costs
to lower lending costs and boost market expenditure in order to save the economy in this state.
Treasury yields result in an increase of this (Provasi and Harasheh, 2021). If an investment's of
those both securities, the rise in bond valuations may assist to counterbalance the decline in
market valuations. Although if earnings aren't higher, the risk is lower.

Whenever a trader chose to buy in any financial asset, not only profits but also dangers
play an important role in the overall procedure. The possibility that the actual benefit from a
transaction may deviate from the predicted return is known as risk. Each investment entails some
amount of danger, and each investment's risk tolerance is unique. There are two categories of
financial hazards: systematic and unsystematic hazards. Systematic hazards are also referred to
as market risks since they have a macro impact (Hannah and et.al, 2021). Rate of interest,
inflationary, equity markets and other types of systemic hazards are prevalent. Unsystematic
hazards are frequently referred to as specialized risks since they impact a single sector or firm.
For instance, a changeover in administration, a defective product, a new major market participant
and so forth. Systematic dangers are universal and impossible to differentiate. Managers seek to
mitigate unsystematic risk by spreading their investment.
Traders anticipate being rewarded for their money is probably hazard and time worth.
Capital Asset Pricing Model is a good way to figure this out (CAPM). It illustrates the link here
between asset's projected return and the systemic risk that it entails. Risk is taken into
consideration when determining the risk free rate, which factors for payback period and hazard.
The element of risk a transaction will bring to the stock market is measured by its beta (He, Chen
and Zhang, 2021). Its purpose is to see if a stock is appropriately valued in capital budgeting and
investment planning when contrasted to the danger and present value it carries. Shareholders'
main objective is to make a profit or return. While putting their money anyplace, buyers should
make an estimate of such possibilities. In such computations, a variety of financial ratios come in
handy. Profits yield, for instance, aids in the determination of the relationship between operating
profits and the share value of shares of a firm. It's similar to the P/E ratio in that it's the opposite
of that figure. It's a useful indicator for calculating financial return. Traders may prepare in a
variety of ways of ensuring that their investment is broad, that their danger is reduced, and that
any costs are offset by potential returns. The following are a few.
• Investors must first determine their tolerance for risk in relation to the expected rewards.
Therefore they should diversify their investment by include money, equities, commodities,
collective investment schemes, ETFs, gold, and other alternative investments (Indriastuti and
Chariri, 2021)

• Diversification is required inside every sort of investment outlet. Variety stocks industry -
specific, enterprise value, geography, revenue, worth, development, and etc.
• Look for and incorporate assets with different risk factors to help offset one another's hazards.
The essential thing to remember is that diversification is a constant process, not really a one-time
event. Owners should check the effectiveness of their assets on a regular basis and alter stocks in
accordance with their strategy and goals.
TASK 2
Valuation of company
It is a method of calculating the economic worth of a firm or a product line in quantitative terms.
When attaching meaning to a corporation, several factors are taken into account, including the
financial performance, profits – current and future possibilities, selling price, and so on.
Appraisal may be calculated in a variety of ways. Discounted cash flow (DCF) analysis, capital
asset pricing model (CAPM), dividend discount model (DDM), and so on are examples
(Chintrakarn, Jiraporn and Treepongkaruna, 2021).
1. Calculation of value of Sporty PLC using following method:
Price/Earnings (P/E) Ratio – It's a proportion that has been used to estimate a business's worth
by comparing its current valuation to its profits per unit. It aids in determining if a business is
cheap or overpriced.
P/E Ratio = Market value per share price/ Earnings per share
RR Ltd (£) Sporty PLC
EPS 0.17 0.105
MPS 6 3
P/E Ratio 0.027 0.035
Working Note 1:
Earnings per share = Net Profit -Preference Dividend
Outstanding shares

(Amount in £m)
Net Profit after tax 6.3
Preference Dividend
(PD)
0
Net Profit after PD 6.3
Outstanding Shares 60m
EPS 0.105
a) Dividend valuation method – It's a mathematical technique for evaluating a company's
worth predicated on the premise that the total of all dividend payments, depreciated equal
to the present value, will equals the price of the stock. The company is discounted
whereas if value gained is more than the current value of the stock, and vice versa. Sporty
PLC is valued using the Gordon Growth Model on the basis:
V0 = D1/ (r-g)
Espirit PLC
D1 (estimated dividend for next period) 8.0355
R (Cost of Capital) 10.48%
G (Growth rate) 7.14%
V0 (Current fair value of a stock) 240.58
Working Note 1: (Amount in m £)
Espirit PLC
Growth = (DPr – DPD) / DPD
Last Dividend Paid (DPr) 7.5p
Previous year dividend (DPD) 7p
G 7.14%
D1 = DPr * (1+G) 8.0355

Working Note 2:
Espirit PLC
Weighted Average Cost of Capital (WACC) = (WD*KD) + (Wc*Kc)
Capital Structure = Capital + Debt
Total Equity Capital 60
Total Debt 15
Capital Structure 75
Cost of Debt (KD) = (Interest Expense/Total debt) * (1-T)
Interest Expense 3
Tax Rate 30%
KD 14%
Weight of Debt in capital structure (WD) = Total Debt / Capital Structure 0.2
Cost of Equity = Rf +B (Rm + Rf)
Risk free rate (Rf) 2%
Beta (B) 1.9
Market Rate of Return (Rm) 6%
Kc 9.6%
Weight of equity in capital structure (Wc) = Equity Capital / Capital Structure 0.8
WACC or R 10.48%
b) Discounted Cash flow (DCF) method – It is a valuation approach that employs the
discounting methodology. It aids in the estimation of a company's worth based on

anticipated retained earnings. It tries to estimate the current worth of an investment asset
associated with future forecasts of how much money it will earn. It may be wrong since it
is based on forecasts and predictions about just the future (Ding and et.al, 2021). The
following formula can be used to generate a discounted cash appraisal:
DCF = CF1/ (1+r)T1 + CF2/(1+r)2 + CFn/(1+r) n
Where,
 DCF = Discounted Cash Flow
 CF = Cash Inflow
 r = Rate of discounting (WACC calculated in question (b) taken)
 t = Time (not given in question, so for ease of calculation 5 years are
assumed)
Year Cash Inflow
(in m £)
R (10.48%) Discounted Cash Flow
(Cash Inflow * r)
1 7 0.905141 6.34
2 7.21 0.819281 5.91
3 7.43 0.741565 5.51
4 7.65 0.671221 5.13
5 7.88 0.607550 4.79
Total discounted cash inflow 27.67
Less: Equivalent initial outlay 20
Net Present value -7.67
Key drivers of valuation methods
Price / Earnings Ratio – Profits, number of shares, and market circumstances are the major
components of the P/E Ratio. In above elements are influenced by a variety of elements,
including retained earnings, firm size, stock market, government restrictions, operational
experience, rate of increase, return on capital, sector - based dominance, earnings durability, and
etc (Klinge, Fernandez and Aalbers, 2021).

As both a motivator for increasing profitability, financial managers must look at a
mixture of cost management and increased sales. They'll also look at the possibility of branching
out into other industries and services. Investors will also maintain a careful eye on the financial
industry's progress. The stock prices are volatile and respond aggressively to any big shift,
whether it is management announcing unanticipated profit/loss or a prospective chance in the
firm's path (Zimon and Tarighi, 2021). Leading companies or firms with a history for delivering
breakthrough productivity solutions have higher P/E ratios, and shareholders are willing to pay
premium prices for their shares. Financial management should be aware of overall economic
weather conditions where the firm works, such as interest rates, operational expenses, jobless
rate, and so on. It has an impact not just on income but also on the stock market.
Dividend valuation method: The dividend, the frequency at which the dividend rises, and the
firm's return on capital are the three major aspects of this system. Consistent financing activities,
retaining strategy, dividend aspirations of investors, cash dividend legislation, payback period,
price of stock and borrowing to the firm, potential cause, and etc influence various aspects.
When estimating the value of a firm or venture, financial planners should take into consideration
that such a method has 3 primary input signals: dividend per share (DPS), DPS growth rate, and
anticipated rate of return. Administrators must maintain a close eye on retained earnings and
guarantee that they are consistent.
The financial leverage of financing is an inside choice made by management, thus in
order to save money for the firm, executives should look into all available investment
possibilities while settling on the one. Investors anticipate a sustained increase in investment
returns from the corporation, consistent with the company's allocation and holding policies.
Leaders are accountable for managing the two. The return on investment is presumed based on
previous facts and projections for the horizon, yet the future is unclear. As a result, measures
must be made in accordance with the risk associated (Baker, Kumar and Pattnaik, 2021).
Discounted cash flow method: This strategy relies only on projections about the future. As a
result, the accuracy is only as good as the expectations. These calculations are based on main
value generators such as unrestricted cash flow predictions, cost of money as a way of
calculating, discounted future rate of growth, forecasting term duration, and so on.

Cash flows have the greatest impact and are the method's most important factor. As a result,
financial planners should concentrate on ensuring constant cash flow. They must constantly
engage in initiatives that raise revenues, lower costs, improve payments methods, and improve
debtor’s circumstances, among other things, to guarantee that the company's worth remains
strong. Because the cost of borrowing is employed as a way of calculating, initiatives to
strengthen capital base and the price of stocks and bonds should constantly be on the finance
dept's agenda. The final valuation rate of increase shows the changes of future cash flows at the
conclusion of the anticipated time. As a result, steps will be taken to improve it. Aside from cash
flow and dividend yield, the duration of the projection period is a crucial determining element.
Increasing or decreasing the timeframe can have a significant influence on the firm's profitability
and outcomes. As a result, it should be addressed to be using duration in accordance with the
business size (Fan, Radhakrishnan and Zhang, 2021).
TASK 3
Investment appraisal techniques
a. The Pay Back period:
Pay back period
Years Cash inflow Cumulative cash inflow
1 200000 200000
2 200000 400000
3 200000 600000
4 200000 800000
5 200000 1000000
6 200000 1200000
7 200000 1400000
8 200000 1600000
Calculation of Pay Back period

Formula of Pay Back period= Completed years + Remaining cash flow/ Next year
cash flow
Here,
Completed year =3
Remaining cash flow= 740000-600000 = £ 140000
Next year Cash flow= 200000
therefore, Pay back period= 3+ (140000/200000)
Pay Back period= 3+0.7 = 3.7 years.
Brief description: The payback period is the amount of time it takes to recoup the upfront outlay.
This period begins out to be 3.7 months in the provided scenario, which indicates the corporation
will be ready to revert the original investment of £740000 in just this period.
b. Accounting rate of return: =Annual profits/ Initial investment
In the given situation,
Annual profits = Expected revenue – Annual cash outflow – Annual depreciation
= £200,000 - £50,250 - £87875
= £615125
Initial investment = £ 740,000
Therefore, Accounting rate of return = £ 615125 / £ 740,000
= 0.83125 * 100 = 83.12%
Accounting rate of return is a method of calculating the rate of interest on any asset or portfolio.
This is derived using the development's starting cost. In this scenario, the return is 83.12%,
implying that the firm will generate a yield that is identical to the estimated return.
c. Net present value: Net cash inflow- net cash out flow
years Cash inflow cash outflow net cash discounting discounted