Posted: September 13th, 2017
Financial Management and Investment markets and principles
In business finance ,evaluation of a project net worth is always a daunting task because there exist many ways of measuring the value attached to the future cash flows
.This is due to the fact that the value of money earned today wouldn’t not have the same worth as money earned in future. Thus Business finance analyst must
incorporate time value of money to get the net present worth of the project proposal. The company`s cost of capital or the discounting rate is the major variable in
the net present value formulae. Different companies have a their own ways of indentifying and calculating the discounting rate, however the most common one is using
the returns which are expected from other investment decisions from other similar projects which carry the same risk.
Hence in definition we can define that the Net Present Value as the difference between the incoming cash flows and the outgoing cash flows over a certain period of
time .In other words the incoming cash flows are regarded as benefits while the outgoing cash flows are regarded as costs .The time value of money is the surrounding
phenomenon behind the computations .Thus the Net Present Value of Investment is usually determined by taking into consideration calculation of the present values of
the total inflows and outflows which is derived by method of discounting the future value of individual cash flows. If the results are positive then the NPV is
Profitable, If the results are negative then the NPV amount to a loss. Thus this method is used the surplus or else the deficit of the cash flows, in the value of
present terms which should be above the cost related to funds .In an empirical or theoretical manner a company which carries out capital budgeting always approves the
projects which yield positive NPV .On the other hand the ,every company is faced with Financial constraints’ thus they may hinder or slowdown the company progress on
investment to the projects with the maximum and desirable NPV, whose the cash flow cost don’t exceed the capital of the company .In addition to that, business finance
analyst use NPV as the core and the fundamental tool in the discounted cash flow analysis and also as the paradigm technique for the usage of the time value of
money. This can be used to weigh up projects which are long term. Economist, accountants’ and financial analysts use this technique widely to value the projects which
would yield maximum returns.Net Present Value method can also be defined as the amount in difference between the arithmetic summation of cash inflows and cash outflows
which are discounted .Inflation and returns are taken into consideration in when comparing the sums of discounted cash outflows and the cash inflows .Formulae used
above
There may be many variables in the formulae but the rate used for discounting is a key factor in this .Most of the companies use the weighted average cost of capital
which is computed after taxes their main rate of discounting .Some other financial analyst believe that its necessary to use a rate above that to accommodate other
macroeconomic variables such as inflation and other financial analyst believe that its necessary to use a rate above that to accommodate other macroeconomic variables
such as inflation and unemployment and the opportunity cost. It goes without mention that the yield curve premium for a debt which has withstood for long can be
evaluated by changeable discounting rate which occur along a time path. However there exist other measures that are used to calculate discounting rate. Such as the
discounting rate can be chosen by decide the rate the investment will return if the same amount is invested in a similar venture. For example for our both proposal
,project 1 and project 2 ,the discounting rate for the NPV calculation will be able to permit comparison to be made on both proposal 1 and proposal 2.There exists a
close relation between the discounting rate and the firms reinvestment rate. In definition the Firm reinvestment rate represents the rate of return for the investment
of the firm on averaging terms. The capital market is always constrained, thus it may prove to be impossible to use the weighted cost of capital as the discounting
rate thus use the firms reinvestment rate. The rate is used to represent the opportunity cost involved in carrying out the investment instead of lowering the cost of
capital. If the variable reduction rates are used to calculate NPV ,the analysis provide a better reflection of the of the financial profitability at the situation
.On the contrary if the NPV are calculated using the discounting rates that are constant for the entire duration of period, the results may not reflect the true nature
of the project profitability.
Some investors, who are very professional in capital budgeting, commit their investment funds to an objective or a target .In such situations, when calculating the NPV
the rate of return should represent the discounting rate. In this method the can be a direct assessment between the desired rate of return and the profitability of the
venture.
Before computing the NPV, many of the business fund managers already set a target return that will be used as a bench mark to discount the net cash inflows from the
proposed project. The net cash flows during the investment period will be subtracted from the expenses which are directly related to generating the inflows in cash
.The NPV indicator is a measure of how much worth does the investment add to the company real asset value. The rules of decision state that the project is only
accepted if the NPV is zero or else it’s positive. The project is rejected if the project is having a negative NPV .In the case one is comparing two mutually exclusive
projects ,both having positive NPVs, the project with a higher NPV is the one which is accepted ,the other with a lower NPV is rejected.
Date Open High Low Close Volume Adj Close
1/1/2015 1157 1157 1157 1157 0 1157
12/1/2014 1191 1210 1112 1157 1689400 1157
11/3/2014 1104 1201 1094 1188 2142500 1180.09
10/1/2014 1035 1108 988.5 1107 2327300 1099.63
9/1/2014 1082 1089 1029 1039 1691900 1032.08
8/1/2014 1040 1108 1009 1082 1508000 1066.83
7/1/2014 1041 1067 995 1043 1824900 1028.37
6/2/2014 1074 1103 1007.05 1036 1739500 1021.47
5/1/2014 1063 1111 1042 1068 1425300 1044.87
4/1/2014 1022 1077 1007 1062 1439400 1039
3/3/2014 1073 1100 1017 1021 1830300 998.89
2/3/2014 1026 1103 1005 1086 2055600 1054.91
1/1/2014 963.5 1070 947 1029 1982300 999.54
12/2/2013 950 966 924 963.5 1328300 935.92
11/1/2013 989.5 1009 942.5 953 1614600 918.25
10/1/2013 922 1007 905.5 988.5 1534300 952.45
9/2/2013 896 941.08 864 919 1667400 885.49
8/1/2013 954.5 966 877.71 883 1704700 843.67
7/1/2013 895 978.5 877.5 949 1819800 906.73
6/3/2013 926 948.5 845 884 2282800 844.63
5/1/2013 874.5 1006 868 933.5 1965100 884.44
4/1/2013 829 892.6 810.5 873.5 1620900 827.6
3/1/2013 829.5 853.5 802 829 1728600 785.43
2/1/2013 803.5 850 798 829.5 1780300 778.85
1/1/2013 813.5 842 746 803 1445000 753.96
12/3/2012 811 830 800.5 813.5 1221700 763.82
11/1/2012 804.5 828 762.5 808 1953000 751.78
10/1/2012 762 818 759.55 804 1733300 748.06
9/3/2012 788 807 761 761.5 1823800 708.52
8/1/2012 792.5 818.5 776.5 791 1736800 729.09
7/2/2012 740.5 801.5 738 790 2141000 728.17
6/1/2012 712 748 702.44 738.5 2430400 680.7
5/1/2012 730.5 755 697.51 709 2118300 648.31
4/2/2012 723.5 745 703 727.5 2475800 665.23
3/1/2012 675 749.5 673 722.5 2738700 660.66
2/1/2012 676 694 665.5 675 2216700 612.42
1/2/2012 635.5 707.5 616.5 674.5 2340800 611.97
12/1/2011 690.5 693.5 608 635.5 1662300 576.58
11/1/2011 672.5 700.44 617.12 687 2306800 623.31
10/3/2011 629.5 722 610 684 2402600 613.91
9/1/2011 740 754 621 642 3626800 576.21
8/1/2011 867 871 694 736.5 3907300 653.92
7/1/2011 853.5 894.66 832.5 855 2927500 759.14
6/1/2011 836.5 859 817 852.5 2791400 756.92
5/3/2011 787 1004 737.9 832 2878500 732.49
4/1/2011 737.5 796 729.5 785 2032800 691.11
3/1/2011 770 780 698 733.5 2915700 645.77
2/1/2011 681 769 675 766.5 3001900 669.58
1/4/2011 694 708.5 668.5 674.5 2386600 589.22
12/1/2010 627 679.5 625 674 1916600 588.78
11/1/2010 682.5 704 625.5 629 2645900 544.58
10/1/2010 645 689 642.5 677 2017800 586.14
9/1/2010 623 656 618 640.5 2590300 554.53
8/2/2010 616 631 592 611.5 2231200 524.87
7/1/2010 551.5 630.5 543 612.5 2573800 525.73
6/1/2010 603.5 638.5 555 558.5 2685600 479.38
5/3/2010 659 678 565.5 601 3792800 511.13
4/1/2010 677.5 702 637 659 2462000 560.46
3/1/2010 637 694 632 678 2547800 576.62
2/1/2010 638.5 678 615.5 632.5 3457900 537.92
1/4/2010 674.5 699 638 640.5 3617300 538.81
SECTION A: SELF ASSESSMENT (TO BE COMPLETED BY THE STUDENT)
In relation to each of the set assessment criteria, please identify the areas in which you feel you have strengths and those in which you need to improve. Provide
evidence to support your self-assessment with reference to the content of your assignment.
STRENGTHS AREAS FOR IMPROVEMENT
I certify that this assignment is a result of my own work and that all sources have been acknowledged:
Signed:____________________________________ Date___________________
SECTION B: TUTOR FEEDBACK
(based on assignment criteria, key skills and where appropriate, reference to professional standards)
1. STRENGTHS AREAS FOR IMPROVEMENT AND TARGETS FOR FUTURE ASSIGNMENTS
MARK/GRADE AWARDED DATE: SIGNED
It is anticipated that marked coursework with feedback will be available to candidates three weeks
(21 days) after submission. Notice of availability will be posted on blackboard.
Assignment/coursework general submission requirements
Written work
• Your student identification number must be clearly stated at the top of each page of your work.
• Each page must be numbered.
• Where appropriate, a contents page, a list of tables/figures and a list of abbreviations should precede your work.
• All referencing must adhere to School/Institutional requirements.
• A word count must be stated at the end of your work.
• Your course, year of study and the relevant module must be included as a “footer” on each page.
• Appendices should be kept to the minimum and be of direct relevance to the content of your work.
• All tables and figures must be correctly numbered and labelled.
• If there is calculation involved you are required to provide workings. Otherwise, no credit will be awarded.
Module: BAC5006 Financial Management Level 2 – Coursework
Case study – Mercia plc.
Mercia plc. owns two acres of derelict land near to the centre of a major UK city. The firm has received an invoice for £50,000 from consultants who were given the
task of analysis, investigation and design of some project proposals for using the land. The consultants outline the two best proposals at a meeting of the Board of
Mercia.
Proposal 1 is to spend £150,000 levelling the site and then constructing a six-level car park at an additional cost of £1,600,000. The earthmoving firm will be paid
£150,000 on the start date and the construction firm will be paid £1.4m on the start date, with the balance payable 24 months later.
It is expected that the car park will be fully operational as from the completion date (365 days after the earthmovers first begin).
The annual income from ticket sales will be £600,000 to an infinite horizon. Operational costs (attendants, security, power, etc.) will be £100,000 per annum. The
consultants have also apportioned £60,000 of Mercia’s central overhead costs (relating to the London-based head office and the executive jet) to this project.
The consultants present their analysis in terms of a commonly used measure of project viability, that of payback.
This investment idea is not original; Mercia investigated a similar project two years ago and believe that there are some costs which have been ignored by the
consultants. First, the local council will require a payment of £100,000 one year after the completion of the construction for its inspection services and a trading
and environmental impact licence. Second, senior management will have to leave aside work on other projects, resulting in delays and reduced income from these projects
amounting to £50,000 per year once the car park is operational. Also, the proposal is subject to depreciation of one-fiftieth (1/50) of the earthmoving and
construction costs each year.
Proposal 2 is for a health club. An experienced company will, for a total cost of £9m payable at the start of the project, design and construct the buildings and
supply all the equipment. It will be ready for Mercia’s use one year after construction begins. Revenue from customers will be £5m per annum and operating costs will
be £4m per annum. The consultants allocate £70,000 of central general head office overhead costs for each year from the start. After two years of operating the health
club Mercia will sell it for a total of £11m.
Information not considered by the consultants for Proposal 2
The £9m investment includes £5m in buildings not subject to depreciation. It also includes £4m in equipment, 10 per cent of which has to be replaced each year. This
has not been included in the operating costs.
A new executive will be needed to oversee the project from the start of the project costing £100,000 per annum.
The consultants recommend that the Board of Mercia accept the second proposal and reject the first.
Assume
– If the site were sold with no further work carried out it would fetch £100,000.
– No inflation or tax.
– The cost of capital for Mercia is 10 per cent.
– It can be assumed, for simplicity of analysis that all cash flows occur at year ends except those occurring at the start of the project.
Required:
(a) Calculate the net present value of each proposal and comment on its financial acceptability.
(30 marks)
(b) Calculate the internal rate of return and the payback for each proposed project.
(30 marks)
(c) Critically evaluate the use of NPV approach in proposed investments.
(20 marks)
(d) Discuss what further information might be obtained to assist a fuller analysis.
(20 marks)
(Total 100 marks)
Assessment Criteria
Standard assessment regulations apply. You must reference your work as required by.
Note: Word limit is 3,000 words. Only printed copy is to be submitted through I-ZONE by due day.
This is assessment One and contributes 50% of the overall module assessment.
Learning Outcomes. On successful completion of this assessment, the student will:
• Demonstrate an awareness of the financial context in which business operate.
• Understand and explain key concepts and models, in this case discounted cash flows.
• Evaluate capital projects/investments using a range of recognized techniques.
• Recognize and evaluate the effect of economic environment for business.
ASSESSMENT GRADING
F Failure to meet learning outcomes
E Failure to meet PASS criteria. Few competencies achieved. Little integration or evaluation of learning exercise. Small amount of remedial work required, may be
compensatable subject to mark in second assessment.
D A basic attempt to answer the question, with little attention to structure. Figures and tabulations substantially correct, though there may be some errors and
omissions. Little evidence of research.
C Satisfactory structure and flow, with minimal errors in composition. Figures and presentation substantially correct. Little evidence of independent research
but satisfactory discussion of main issues.
B As for ‘C’ plus answer displays familiarity and comprehension of the issues, but without a great deal of independent or critical comment. Majority of figures
correct and presented in an appropriate fashion. Evidence of research of current sources of information and correct referencing.
A As for ‘B’ plus answer displays evidence of independent criticism and analysis. Free from errors and all relevant points discussed. Research includes
investigation of current issues. Research correctly referenced.
Graduate Skills assessed: 1a, 1b, 1d, 2a, 2b, 2c, 3c, 4a, 4b, 6a, 6b, 6c, 6d, 7b & 7c.
Skill Category Skill Elements to be developed
1. Communications a. Written
b. Presentation: verbal and written
c. Listening and interpretation
d. Reading and interpretation
2. Numeracy a. Calculation/estimation
b. Understanding conventional numerical data.
c. Handling and interpreting date.
3. Technology a. Use/application of ICT
b. Electronic communications
c. Information retrieval and manipulation
4. Learning and Study a. Personal time management
b. Learning/study/search
c. Learning technology
5. Interactive Group a. Team working
b. Taking initiative
c. Leadership/managing others
6. Problem Solving a. Identifying key issues
b. Planning
c. Managing tasks
d. Creativity and originality
7. Professionalism a. Ethical evaluation
b. Responsibility
c. Entrepreneurship
d. Self reflection evaluation
e. Career/career development awareness.
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