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Financial Management Role

University: University of Sunderland in London

  • Unit No: 7
  • Level: High school
  • Pages: 19 / Words 4784
  • Paper Type: Assignment
  • Course Code: APC 308
  • Downloads: 221
Question :

This sample will let you know about:

  • Discuss about the Scrip Dividends.
  • Discuss about the Advantages and disadvantages of investment appraisal techniques.
Answer :
Organization Selected : N/A

INTRODUCTION

Financial management is amongst the important sector to be considered by the business. Excellent knowledge of financial management is required for running the business successfully. Financial management deals with strategic planning, to organise, direct and control the financial undertakings of organisations. It involves application of management principles in the business. It enables the company to have adequate and regular supply of the funds. It ensure that the adequate returns are generated to the shareholders that depends upon the earning capacity of the business. Financial management deal with effective utilisation of funds within the company. It ensures safety of the enterprise over the investments options it is planning to adopt for the business. Study is focused over the ways of raising funds by the management with least costs. Also the tools & techniques used in investment appraisals have been demonstrated in the report. Question number 2 & 3 have been answered in this report that are related to right issue and capital budgeting techniques.

a) Issue of right shares

Right issue- It means the way through which company could raise capital by issuing the share to an existing shares at lower price rather than going for issuing of new shares. Right offer or right issue is form of dividend giving subscription rights for buying the additional securities in company given to the existing shareholders (Pathak and Gupta, 2018).

Lexbel company decided to raise the funds for issuing the right shares for the purpose of creating expansion in an existing operations. The financial data are as follows-

Particulars

Amount (£)

Amount (£)

Amount (£)

Expected amount to be raised

180000

 

 

Market value of the current ex dividend

1.9

 

 

Recommended price for right issue

1.8

1.6

1.4

Ordinary shares @ 50 pence each

300000

Add: Reserves

400000

Total

700000

Profit After tax

700000*20%

PAT

140000

 

b) Computations

i. Number of the shares that are required to be issued= Fund need to be raised/ price of right issue

Particular

Amount (in £)

Amount (in £)

Amount (in £)

Number of shares already existed

600000

600000

600000

Fund needed to be increased (1)

180000

180000

180000

Recommended price for right issue (2)

£1.8

£1.6

£1.4

No. of shares needed to be issued (3)= 1/2

100000

112500

128571.43

(ii). Calculation of theoretical ex-right price

Theoretical ex-right price – It could be defined as the estimated share price of company after company has brought the right issue. The theoretical prices represents the market price of share on theoretical basis. Prices of theoretical ex rights are less than the market prices of the shares. They are calculated on weighted average basis. Rights offering are made at first to the existing security holders of company. Order assignment help from our experts! 

Particulars

Scenario 1

Scenario 2

Scenario 3

Recommended right issue price

1.8

1.6

1.4

Funds need to raised

180000

180000

180000

No. of the shares required to issue

100000

112500

128571.43

Pre right shares issue

1140000

1140000

1140000

Post right shares issue

1320000

1320000

1320000

Theoretical ex-right price

1.89

1.85

1.81

(iii) Computing expected earning per share (EPS) = (Shares before the right issue*theoretical ex-right price)/ Market price of shares

Particulars

Amount (£)

Current market price

1.9

Existing no. of the shares

600000

Return on the shareholders fund

140000

Particulars

Amount (£)

Amount (£)

Amount (£)

Suggested price for right issue

1.8

1.6

1.4

Funds needed to raised

180000

180000

180000

No. of shares required to issue

100000

12500

128571.43

Pre right shares issue

1140000

1140000

1140000

Post right shares issue

1320000

1320000

1320000

Theoretical ex-right price

1.89

1.85

1.81

One right value

0.01

0.05

0.09

Fair market value for each and every share

95454.55

97159.09

99350.65

Bonus fraction

50619.83

52443.83

54836.4

Expected EPS

595488.72

585041.55

572136.22

(iv). Different forms of issuing right issue shares at different price

Particulars

Amount (£)

Amount (£)

Amount (£)

Suggested price for right issue

1.8

1.6

1.4

Funds needed to raised

180000

180000

180000

No. of shares required to issue

100000

112500

128571.43

Existing no. of the shares

600000

600000

600000

Ratio of the new shares to an existing share

0.17

0.19

0.21

Issue of the right issue hold by an existing shareholders

Issue of 1 shares for 6 right shares

Issue of 9 shares for 48 right shares

Issue of 3 shares for 14 shares held

(v)Assessing the best option

From the above analysis it has been interpreted that option 1 that is issuing the right shares at £1.80 seems as the best option for the company. It is because an estimated cost relating to earning at this point of level is higher than the other two options.

c) Shareholders opting for scrip dividends rather than cash dividends.

Dividend

Dividends is form of return to the shareholders for their investments. It is distribution of profits earned by company during the year. Dividends are paid at specified percentage by the corporations. Before the dividends are decided approval of shareholders is required to be taken

Scrip Dividends

Shareholders are nowadays are shifting their interests in the form of receiving the dividends. Previously shareholders were more concerned over getting dividends in form of cash. Company was paying dividends only in monetary terms. This many of times affected the business and the liquidity position of company. By the time new methods of dividend are evolved. Shareholders today are more interested in increasing their wealth instead of receiving the cash returns.

Scrip dividends refers to form of payment where the shareholders of company are given the choice in type of dividends. They are given options to receive either the cash dividends or the stock dividends (Feito-Ruiz, Renneboog and Vansteenkiste, 2018). Shareholders are given the shares of company for the dividends. This increases the wealth of shareholders without any extra payments. Companies are highly benefited by the the scrip dividends and their demand is increasing in the market. This is paid when the return is to be given but the funds are to be used for expansions.

Benefits of the scrip dividends to company.

  • This helps company to save monetary funds by issuing stocks rather than the cash dividends by giving them choice for dividend types.
  • Companies by paying the dividends in form of shares can use the monetary funds in running the operations of company effectively.
  • Lack of funds will not affect the return policy of the company as dividends in form of share are paid.
  • Company giving shares as dividend do not have to pay dividend tax over the scrip dividends.

Benefits of the scrip dividends to shareholders

  • Shareholders can increase the share of ownership in the company without any additional payments.
  • Increased shareholding will provide them with increased yields over their investments (Bernhart and Mai, 2016).
  • Recipients of scrip dividend do not have to pay brokerage or other charges for the shares.
  • Shareholder's wealth is increased without additional investments.

d) Identifying feasibility of project by using techniques of capital budgeting

Every company conducts business with the motive of earning profits. Companies along with its regular operations are required to take decisions for their growth and expansion. Finance is the life blood of every business and it is essential for the business to identify that its resources are used efficiently. Companies before investing the funds are required to verify whether their investments will be generating adequate returns or not. To identify the feasibility of the project or portfolio various investment appraisal techniques are used. Objective of the financial management is placing value on the benefits so that costs are justified. The decision is taken after carrying out thorough research and study by the organisation as huge funds are invested for the project (Maáji and Barnett, 2019). The most commonly used appraisal techniques are internal rate of return, accounting rate of return, net present value and the pay back period. They give proper guidance to the management about the techniques of investments. Company is a food manufacturer who for producing new food items is planning to buy machine of £275,000. Machine will be depreciated at straight line basis with the residual value of 15% of cost and useful life of 6 years. Need example assignments, Talk to our experts! 

Pay back period

Years

Cash inflows

Cumulative Cash Flows

1

72500

72500

2

72500

145000

3

72500

217500

4

72500

290000

5

72500

362500

6

72500

435000

 

 

3

Initial Investment

 

275000

 

 

0.9

Payback period

 

3.9 Years

Working Note :

Cost of Investment = 275000

Final Cash flow = Inflows- outflows

= 85000-12500 = > 72500

Payback period

= 275000/72500 = > 3.9 years.

Findings

Payback period shows the time taken by the investment in which it will be recovering its cost. Cash flows generated from the machine shows that its initial cost will be recovered in 3 years & 9 months. The payback period is not long therefore it could be suggested that the project should be accepted by Lowell limited. Shorter pay back period of the project will help the company to generate quick returns.

Accounting Rate of Return

Depreciation = Cost of assets – Scrap value / Life of machinery

Particulars

Amount

Cost of machine

275000

Less- Scrap value (15% of cost of machine)

41250

 

233750

Depreciation = 233750 / 6 => 33958.33

Computation of Accounting rate of return

   

Year

Cash inflows

 

 

1

33541.67

2

33541.67

3

33541.67

4

33541.67

5

33541.67

6

33541.67

 

 

Average profit or cash inflow

33541.67

Average initial investment

275000

average initial investment [(initial investment + scrap value) / 2]

 

ARR

12.19%

ARR = (33541 /275000)*100 =>12.19%

Findings

ARR represent the returns generated by the project. On calculations ARR from the given cash inflows and outflows is 12% approx. Rate of returns is adequate as per the similar projects. Machine is purchased for increasing the returns and improving the performance. The rate of return will help the company in achieving both returns and improved performance.

Net present value

Computation of NPV

 

 

 

 

Year

Cash inflows

PV factor @ 12%

Discounted cash inflows

 

 

 

 

1

72500

0.893

64732.14

2

72500

0.797

57797

3

72500

0.712

51604

4

72500

0.636

46075

5

72500

0.567

41138

6

113750

0.507

57629

 

 

 

 

Total discounted cash inflow

 

 

318976

Initial investment

 

 

275000

NPV (Total discounted cash inflows - initial investment)

 

 

43976

Findings

It is calculated for knowing the present worth of the money that will be generated in future. It is an important method used giving more reliable results. NPV of the project is 43976 and is positive. This represents that the company will be profitable in adopting the project. It is measured by subtracting the investment cost from the present value of cash flows.

Internal Rate of Return

IRR = Lower discounted rate + NPV at lower discount rate / (NPV at lower discount rate- NPV at higher discount rate) * Higher discount rate- lower discount rate

Working notes:

Net present value @ 12%

Net present value = 297828-275000

= £22828

Net present value @ 18%.

Net present value = 253576-275000

= -£21424

Findings

It helps the company to measure the rate of return generated by the projects. Machine will be having IRR of 15% approx. This is calculated by taking the assumptions of rates. The outcomes shows that the return rate is adequate from the machine and company will grow adopting this project.

e) Advantages and disadvantages of investment appraisal techniques.

Payback period

Payback period refers to time period needed for earning back the investment costs. It is essential for the organisations to know the time length that investment will be taking to recover cost so that profits could be generated. Longer period will be referring to loss of money. There is negative effects on the cash flows till the break even point is achieved by the company and profits have been started. It is used typically for evaluating the project before undertaking them, by evaluation of associated risks. Project or portfolio with shorter pay back period is considered as profitable as the risk levels associated with investments will be for shorter period (De Souza and Lunkes, 2016). For determining whether payback period of project is favourable or not, management will be determining desired payback period for recovering initial costs. The method is un-discounted investment appraisal technique.

Benefits

  • Project with longer pay back period represents the capital tied up.
  • Companies focus over enhancing the liquidity of company by shorter pay back periods.
  • It can makes forecasts for shorter terms.
  • The technique gives more reliable results as compared with other.
  • Calculations are not tricky or tedious of the pay back periods.
  • It is considerably simple and easy technique.
  • It is easy to understand and interpret the results of this technique.

Limitations

  • Technique do not considers timings between the cash flows.
  • It also ignores the cash flows generating after end of the payback period and ultimately total return from the project (Bernhart and Mai, 2016).
  • Concept of time value is ignored in the pay back period.
  • It influences for excessive investments in the short term projects.

Accounting Rate of return

The technique is also recognised as return on the investments, it provides annual accounting returns arising from the project or portfolio as the percentage of investments made. In other words it is investment formula used for measuring annual earnings over the investments that are expected by the organisations. It calculates the amount of money or the return generated from a project or portfolio. ARR is important as it helps the investor in analysing the risks involved in the project or portfolio and to decided whether the profits or returns are adequate for accepting the associated risk levels. Every company makes some or the other kind of investments and it is important to know their returns as funds are involved (Magni, 2019). Accounting rate of returns is also an un-discounted method of calculating the returns. It is also a technique of capital budgeting that is used by the experts or investors to know whether it is feasible or not to make the investments.

Benefits

  • ARR helps in comparing the new projects with the cost efficient or other projects which are competitive.
  • Method makes it easier to calculate and understand the returns generated from investments.
  • It provides clear view about the profitability of the project.
  • Investors are interested in the returns and method provides them returns in percentage terms (Siziba and Hall, 2019).
  • Accounting profit concept is considered in this method.

Limitations

  • The method ignores time factor while calculating alternative usage of funds.
  • It do not accounts for the external factors affecting the earning capacity.
  • Different results are generated by ROI and ARR.
  • Method is focused only towards the accounting profits and do not consider the cash inflows.

Net Present Value

Net present value is among the several techniques that are used by the businesses for selecting the projects or identifying their feasibility. In this method project is accepted or rejected on the basis of Net present value. It represents the estimated profitability from the project or portfolio. NPV of the projects is based over the future cash inflows and the initial cost of asset or investment (Haghshenas, Gholamalifard and Mahmoudi, 2017). Advantage of NPV are causing the organisations to use it and the limitations are prompting to use the alternative methods. Method is based over time value of money concepts. The present worth is required to be calculated to know whether cash flows are enough for recovering the cost of investments (Net Present Value, 2019). It is used by organisation to assess the profitability of the project or investments. Ask for management assignment help from our experts!         

Benefits

  • Method considers time factor in its calculations.
  • Savings or earnings over entire life of the asset is considered. These savings or earnings are converted into present worth of money.
  • It is helpful in making comparative analysis between the different projects.
  • In this method project having highest NPV is to be selected. It leads to profit maximisation for the organisation (Adusumilli, Davis and Fromme, 2016).
  • The method can be used in both even & uneven patterns of cash flows.

Limitations

  • It do not represents rate of return expected from an investment.
  • Method is not useful for comparisons between projects with different level of investment.
  • Method requires proper knowledge of the cost of capital.
  • NPV leads to contradictory and confusing answers while ranking complicated projects.

Internal Rate of Return

IRR is used by the organisations for measuring and comparing profitability of the various projects and the investments of the business. It is the common measurements tool for the decision making by the investors. IRR is a interest rate which is used for discounting the cash flows from the project. It is also techniques used for evaluating the attractiveness of the investments or projects (Arjunan, 2019). If IRR of project exceeds the required rate of returns project is considered to be desirable by the company. This is discounted method of investment appraisal t

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