Posted: January 15th, 2015

Financial Management and Investment markets and principles

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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