Business Finance Report: Investment Appraisal and Financial Analysis

This report delves into various aspects of business finance, including investment analysis, risk and return assessment, and project evaluation. It begins by identifying and analyzing the risk and return associated with a potential investment, utilizing techniques such as standard deviation and the Capital Asset Pricing Model (CAPM). The report then calculates the Weighted Average Cost of Capital (WACC) for the company, considering the market values and costs of different funding sources like debt, preference shares, and equity shares, and compares the WACC with shareholder expectations. Finally, the report evaluates two investment proposals using the Net Present Value (NPV) approach, providing a comparative analysis to aid in decision-making. The report concludes by summarizing the findings and emphasizing the importance of these financial concepts in business operations. The assignment adheres to the University of South Australia's BANK 2007 course requirements for business finance.

Business finance

Table of Contents
Introduction................................................................................................................................3
1..................................................................................................................................................3
2..................................................................................................................................................5
3..................................................................................................................................................7
Conclusion..................................................................................................................................8
References..................................................................................................................................9
Appendix..................................................................................................................................10

Introduction
In business, there are various financial aspects that need to be considered and accounted for.
In this report, there will be the use of the available data and with that various processes will
be performed. The risk and return of the project will be identified and taken into account for
the purpose of evaluation. The WACC will be calculated for the company by which the cost
of the funds will be ascertained. The other project appraisal techniques will be used such as
net present value and with the help of that proper decision making will be taken into account.
All of these will be undertaken for the evaluation of the various proposals which are available
with the business.
1.
Investment is required to be made by the business and in that there are various aspects which
need to be taken into account. In this process, there is the inclusion of the risk and return for
the investment that shall be identified (Leys et al., 2013). The possible returns are provided
and with that, the probability of their occurrence is also given and they will be used to
calculate the expected return and the standard deviation. With the help of the same and
making a comparison with the market risk and return the final decision will be made. The
calculations are performed for the same and they are reflected below:
Returns Probability Probable
returns
Deviatio
n from
mean
Square
of
deviation
-4 0.15 -0.6 -2.9375 8.63
7 0.35 2.45 0.1125 0.01
14 0.45 6.3 3.9625 15.70
24 0.05 1.2 -1.1375 1.29
6.41
Expected return 9.35
Average return 2.3375
Standard deviation 2.53
Standard deviation formula:

= √ (25.64)/4
=2.53
The standard deviation is determined to be at 2.53 whereas the market risk is 7.5%. Standard
deviation denoted the level of the risk which is involved in any proposal and by those
effective decisions will be made (Wan et al., 2014). In the given case there is less amount of
risk which is involved. As the risk in the investment is less so the same will be advisable and
shall be undertaken as the lesser risk will be faced.
In this, the consideration is given to risk only and so there will be the use of the capital asset
pricing model. This is the technique in which the relation between risk and return is taken
into account. By this there will be the inclusion of both the aspects and more accurate results
will be obtained. The calculation of this will be made with the help of the formula which is as
follows:
Return = Rf + b(Rm-Rf)
= 3 + 1.1 (8-3)
=3 + 5.5
=8.5%
It can be noted that the return which is required by business that is 9.35% is higher than the
return with CAPM. Due to this, the investment is not advisable as the business will not be
beneficial as per the requirements which are set.
Diversification is the technique in which the company will be required to make the
investments in the various businesses which will be included in the portfolio of the company.
The achievement of the diversification is made by including the various types of investment
in the portfolio of the company (Titman et al., 2019). By this, the scope will be expanded and
business will have different elements from which the amount will be earned. With the
investment in different companies, diversification is accomplished as the portfolio will be
including various types of investments. All of the companies have different conditions and

elements and with the incorporation of all, there will be the attainment of the diversification
in the company.
2.
The company is using various sources for the funds and they have different market values. It
is required that the market value shall be ascertained as that will help in the further
calculation. The determination of the same will be made and with that, there will be
ascertainment of the cost of all the sources (Hou, Van Dijk and Zhang, 2012). That will
further be used in the determination of the weighted average cost of capital. All the
calculations in this respect are provided below.
Market value of the various sources:
Debt = C[(1 – (1/((1 + Kd)^t)))/Kd] + [FV/((1 + Kd)^t)]
Where,
C = Interest
Kd = cost of debt
T= maturity
FV = total debt
Kd = 5*(1-0.3)
= 3.5%
Market value of debt = 2400000[(1 – (1/(1+0.035)^5)))/0.035]+[40000000/((1+0.035)^5)]
= 2400000 [4.515] + [33678927]
= 44515052
Market value of preference shares = 1000000*11.45
= $11450000
Cost of preference share = 1.20/11.45
= 10.48%

Market value of equity shares = 50000000*1.88
= $94000000
Cost of equity = (D1/P0) +g
= (0.1957/1.88) + 0.03
= 13.41%
Calculation of WACC =[(Market value*kd)+ (Market value *kp)+ (Market value *ke)]/ total
Market value
Particulars Market
value
cost of
source
Weighted
market
value
Debt 44515052 0.035 1558027
Preference
share
11450000 0.1048 1199960
Equity share 94000000 0.1341 12605400
14996505
2
15363387
WACC 10.24%
The expected return of the shareholders is 12% but the WACC is determined to be 10.24%
which is less than the required rate. Due to this, it can be said that the investors will be less
attracted to the investments as they will not be able to get the required returns from the
investments.
The dividend valuation model is used for the equity and under this approach, the dividend
which is expected to be paid is taken into account in comparison with the market price which
is prevailing in the market (Hann, Ogneva and Ozbas, 2013). With the help of this, the return
which will be available to the shareholders with the investment is identified on the basis of
the market value. In this, there is the consideration of the growth which is involved by which
the accurate position will be determined by considering the future consequences. This model
can also be used for the preference shares as in that also the dividend is required to be paid to
the holders of the shares. The main limitation which is involved with this method is that in

this dividend is the main base and it is not always possible to project the same in an accurate
manner and if the company is not involving the payment of dividend then this method will
not be used (Frank and Shen, 2016). There are various assumptions that are used under this
and also the earnings and tax rates are not taken into account which is another drawback of
the same.
3.
In the business, there are two proposals that are available and it is required that they shall be
evaluated in an effective manner. For that, there are various techniques that can be used and
one of them is a net present value approach. In this, there will be consideration of the inflows
and their present value. They will be compared with the outflows and the net value which
will be available with the business will be identified (Žižlavský, 2014). The decision will be
taken on the basis of this as it covers the time value of money which is neglected by other
techniques. In this technique, there is the use of the rate by which the present value is
determined. This will be creating certain issues for all of those projects which are of long
duration as the calculation is made by considering the constant cost of capital. With time
there is the change in the rate which is faced and the same is considered to be the limitation
for the same. In spite of this, there are the best results which are obtained with the help of this
technique and so shall be taken into account in making effective decisions. The calculations
which will be made under this are presented below.
Calculation of NPV
Project 1
Year Cash flow PVF @ 12% PV
0 -
55000000
1 -55000000
1 13000000 0.892857 11607143
2 13000000 0.797194 10363520
3 13000000 0.71178 9253143.2
4 13000000 0.635518 8261735
5 13000000 0.567427 7376549.1
6 13000000 0.506631 6586204.6
7 13000000 0.452349 5880539.8

Total PV of inflows 59328835
NPV 4328835
Project 2
Year Cash flow PVF @ 12% PV
0 -
60000000
1 -60000000
1 11000000 0.892857 9821428.6
2 11000000 0.797194 8769132.7
3 11000000 0.71178 7829582.7
4 11000000 0.635518 6990698.9
5 11000000 0.567427 6241695.4
6 11000000 0.506631 5572942.3
7 11000000 0.452349 4975841.4
8 11000000 0.403883 4442715.5
9 11000000 0.36061 3966710.3
10 11000000 0.321973 3541705.6
11 11000000 0.287476 3162237.1
Total PV of inflows 65314690
NPV 5314690.5
It can be noted that there is a positive result that is obtained in both of the proposals and both
will be beneficial for the business (Pasqual, Padilla and Jadotte, 2013). The gain which will
be made is higher in the case of Project 2 and so this will be more beneficial for the company.
This will be taking a longer duration and due to that consideration will also be made to the
other aspects which are involved in this relationship such as the risk and other elements
before making any decision in this respect.
Conclusion
The report has been prepared in which there are various aspects that have been evaluated and
with the help of that the position and performance of the business are taken into account.
There is the consideration of the risk and return which are available in the business and the

risk is involved and shall be considered. The calculations have been made and by that the
calculation of the weighted average cost of capital is made which is less than the required rate
and that is not in the favor of the investors. The evaluation of the projects is made with the
help of NPV and by that the final decision can be taken by the company.
References
Frank, M.Z. and Shen, T. (2016) Investment and the weighted average cost of
capital. Journal of Financial Economics, 119(2), pp.300-315.
Hann, R.N., Ogneva, M. and Ozbas, O. (2013) Corporate diversification and the cost of
capital. The journal of finance, 68(5), pp.1961-1999.
Hou, K., Van Dijk, M.A. and Zhang, Y. (2012) The implied cost of capital: A new
approach. Journal of Accounting and Economics, 53(3), pp.504-526.
Leys, C., Ley, C., Klein, O., Bernard, P. and Licata, L. (2013) Detecting outliers: Do not use
standard deviation around the mean, use absolute deviation around the median. Journal of
Experimental Social Psychology, 49(4), pp.764-766.
Pasqual, J., Padilla, E. and Jadotte, E. (2013) Equivalence of different profitability criteria
with the net present value. International Journal of Production Economics, 142(1), pp.205-
210.
Titman, S., Keown, A.J., Martin, J.D. and Martin, T. (2019) Financial management:
Principles and applications (8 ed.). Pearson Australia, Melbourne, VIC.
Wan, X., Wang, W., Liu, J. and Tong, T. (2014) Estimating the sample mean and standard
deviation from the sample size, median, range and/or interquartile range. BMC medical
research methodology, 14(1), p.135.
Žižlavský, O. (2014) Net present value approach: method for economic assessment of
innovation projects. Procedia-Social and Behavioral Sciences, 156, pp.506-512.

Appendix