Financial Analysis: Share Valuation and Investment Appraisal

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Financial Management
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Table of Contents
1...................................................................................................................................................................3
A..............................................................................................................................................................3
B..............................................................................................................................................................7
C..............................................................................................................................................................9
3.................................................................................................................................................................10
A............................................................................................................................................................10
B............................................................................................................................................................15
References:................................................................................................................................................17
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1
A.
Valuation of Share
Valuation of share is a financial technique which helps management to identify the value of the
share for the company. Valuation of share is a technique which identified the company to know
their net worth and also guide management to identified share prices of the shares in the market
(Penman, 2015.). There are some of the methods are used by management to identify the share
value of the company.
 Net Assets Method – Net Asset method is a method which enables management to identify
their share value on the basis of their net assets in the balance sheet (SHMA, 2014,). The
company divided numbers of share with net assets to identify the fair value of a share for
business and their activities.
Formula = Net Assets/ Numbers of Shares
 Income-based Method - Income based method is used for the valuation of share for the
purpose of business. This method is used by the company to identify the fair value of share
which is dependent on Income generation from business activities of the company (Penman,
2015). The fair value of a share in Income based method is calculated on two different
methods which are as follows-
o Discounted Cash Flow Method
o Price earning Method
 Market-Based method – Under this approach Fair value of a share is calculated on the
market value of the share. This is the most suitable methods for the companies which are
listed in the open market and operated their business activities. In this method, two
approaches can be used for the calculation of the value of the share.
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o Earning Yield method – In this method Value of share is calculated on the basis
expected to earn rate for the share of the company. Under this method value per share
is calculated as follows –
o Dividend yield Method – Under this method the value of a share is calculated on the
basis of expected dividend paid to their equity shareholders and the normal rate of
return. In this method share value included the expectations of an investor in terms of
dividend policies for the company (SHMA, 2014,). In this method, the value of a
share is calculated as follows –
Here the company wants to know their fair value of share which is based on the dividend policies
of the company. Further dividend from, previous year is given in the problem which indicates
that Dividend Yield method is the most suitable tools and techniques to the identified the fair
value of a share for Planet's share. Here Growth rate is needed for valuation of share for that
purpose company need to used the Gordon growth model for calculation of the value of the
share.
Gordon growth model – In recent time valuation models for share is calculated share value on
the basis of constant dividend rate for the company which not provides an adequate and
corrected value of the share (InvestingAnswers. 2019). Gordon model is introduced which
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consider the growth rate of dividend policies for calculation of fair value of the share. It is a
Stock valuation method which provides the fair value of share while considering future growth
of the dividend policies for the company.
Formula =
Given Information’s
Year Dividend rate
0 13%
1 14%
2 17%
3 18%
4 20%
Cost of Capital 14%
Working Note
Calculation of Growth Rate
D1 = D0(1+g)
(1+g) =
(1+g) =
(1+g) =
(1+g) = 1.113708
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∜(D0/ D1)
∜(20/13)
∜ 1.538
Valuation of Share = D1(1+g)
K-g
Valuation of Share = 20*(1+0.113)
.14-.113
Valuation of Share = 22.26
0.027
Valuation of Share = 824

Growth rate = 1.113708-1
Growth rate = 11.37%
The share value of Planes is 824 (Approx.) which is calculated on the Gordon growth model for
the company.
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B.
Planet wants to changes their capital structure in the near future which can help them in
decreasing financial cost as they want to invest their money in equity share for the company.
This change can be to increase the financial leverage and also the cost of capital for equity
shareholder of the company. Planet implemented the strategic decision of changing in a capital
structure which influences the expected rate of return for the company. There is a negative
change for the company as the expected rate of return of shareholder is increased from 14% to
15.3% which also can impact the valuation of share and company also.
Value of stock =
D1= current year’s dividend
R = shareholder’s required rate of return (15.3%)
G= growth rate
Year Dividend rate
0 13%
1 14%
2 17%
3 18%
4 20%
Cost of Capital 15.40%
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Valuation of Share = D1(1+g)
R-g
Valuation of Share = 20*(1+0.113)
.154-.113
Valuation of Share = 22.26
0.041
Valuation of Share = 543
Calculation of growth rate
D1 = D0(1+g)
So here
(1+g) =
(1+g) =
(1+g) =
(1+g) = 1.113708
Growth rate = 1.113708-1
Growth rate = 11.37%
As the decision of change in capital structure impact on the price of the share which reflects a
decrease of 281 in the value of the share. Further valuation of a share of the company is going
down due to the strategic change in the capital structure for the company. The new value of the
share of the company is 543 as the increase of expectations of investor toward the company.
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∜(D0/D1)
∜(20/13)
∜ 1.538

C.
Gordon Growth Model is a suitable tool to evaluate and determine the value of a share for the
company. This model works on a certain assumption and also has some of the limitations which
can be needed to be understood by management to identify the proper valuation of share
(Dividendmonk, 2017). The limitations of using the dividend growth model as a way of valuing
shares are various. Some of them are listed as follows:
 Gordon growth models are highly sensitive in relation to the normal rate of return and
expected the rate of return by the investor. If there is a minor change in the expected rate of
return there will be a huge difference in the price or value of the share. As in the above
scenario there is a minor change in the rate of 1.4% which reflects a major difference of 281
of the value of the share. It can be sensitive in the information flexibility for the near future
which can be a major issue related to the Gordon growth model for valuation of share.
 Dividend growth model also had an assumption of constant value or rate of the growth in
dividend policies for the company. This can be a major drawback of the model as the growth
of the share or dividend is not consistent for the time period. Growth in the market is flexible
in nature which can mainly cause the calculation for the value of the share of the company.
 The growth model is related to the information of the expected rate of return and growth rate
of return for the valuation of the share. If the growth rate is higher than the expected rate of
return this model is not able to identify the value of the share for business. This is an
imitation of the model as it can be identified according to the growth rate and expected rate
of return for the share in the market. For example, if the growth rate is 15% and Expected
rate of return is 12.5% than the Gordon growth model is not able to identify the valuation of
share for business.
 The dividend growth model assumes that the earnings and dividends are directly
proportional to each other. The model states that the company pays a higher dividend as the
earnings go up. This does not hold true in the real-life business situation because it is not
necessary that a company pays higher dividends as the earnings go up. The company might
borrow cash in order to pay dividends and maintain a stable dividend payout ratio.
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3.
A.
Investment appraisal – Investment appraisal is a financial tool which is included various tools
and techniques that can be helpful for management in the better evaluation of projects and also
for strategic decision-making in the buyback of the projects (Rossi, 2015). Here some of the
tools and technique are identified and discussed which provide relevant information for decision
making of the company.
Payback Period for project
In the time when Project cost is fully recovered by the revenue from operations and net profit
value becomes zero. That Time period is called as Payback Period. Payback period is a tool
which helps management to identify a time period in which they can recover their cost or
investment in the project from their revenue generation from business activities.
Discounted Payback
Period = Completed year + Remaining income for Cost of the project
Annual Income of Next year
Discounted Payback
Period = 4 + 52,080
55,730
Here Payback Period for this project X is 4.93 in which company can set off the cost of the
project from their revenue earned. It defines that the company can recover their investment cost
in the time period of 4.93 years and after they start earning profit which helps in wealth
maximization for the company.
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Accounting Rate of Return
Accounting rate of return is a technique which identified profit from the operations of the
organization and evaluates that profit in the context of average investment in the project
(Accounting tools, 2018). It helps management into identified profitability of the project and also
evaluates a minimum return rate from the project in the near future on which company can take a
decision
ARR = Average Net profit X100
Average Investment
ARR = 55,730.00 X100
158125.00
ARR = 35.24%
Working Notes –
Average Investment =
Initial Investment + Salvage
Value
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Average Investment = 158125
In this study, ARR is 35.24% which identified that company is in profitable condition if they
adopt the project for the operation further they can rely on the rate which guides them to accept
the project as it can be a profitable option for the company to expand their business in near
future.
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Net Present value
Net Present value is a method which identified net cash inflow and a cash outflow from the
project in which management wants to invest their fund in the near future (Accountingcoach,
2018). NPV is a capital budgeting tool which helps management in identification of profitable
project for the decision-making of buy and bank of the projects.
Given Information
Particular Amount ( In £)
Initial Investment 275000
Life of the project 6 Years
Salvage value 41250
Annual cash inflow 85000
Annual cash outflow 12500
Cost of Capital 12%
Net Present Value of the project
Particular Amount ( In £)
Initial Investment 275,000
Net Cash Flow (Annually) 229,277.00
Salvage Value 20,914.00
Net Cash flow ( Outflow) 24,809.00
As per Net present value company can reject the project as the project has a cash outflow of
24,809 in the near future. As the company faced the financial loss from the project so they don't
have to invest their fund in the option of machinery which had future losses. Lovewell is not able
to accept the project as they had a financial loss of 24,809 from the project.
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