• Understand key managerial finance issues and their management.
• Balance the drivers of using profit as a measurement of performance against the
drivers of using cash, and assess financial performance
• Identify and appraise investment opportunities, taking account of cost of capital and
risk, including incremental cash flows and investment appraisal
Core Investment Appraisal Techniques
ARR: Average return on investment as a percentage of the cost of that investment, using profits
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Profits can vary more than cash flows
Profits depend on subjective estimates such as depreciation, stock value, and provision for
doubtful debts
PBP: How long it takes for the business to recover the initial cash outflow to purchase the fixed
asset.
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Takes no account of cash flows occurring after payback point reached
Simple concept, business decisions are risky.
Discounting Cash Flows: Value of money changes with time (opportunity cost of investing and
earning interest)
NPV: Sum total of all the present values of all cash flows for the project.
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Assumes all cash flows occur on last day
Cost of capital is assumed to remain constant over the lifetime of project
IRR: Average annual rate of return project is expected to produce
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Linear approximations used when calculating IRR (mathematically incorrect)
IRR is a relative measure, whereas NPV is absolute
Questions to ask about forecasted sales and profits:
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Are the proposed sales volumes reasonable?
Will competition bring better alternative to the project?
Are the proposed selling prices reasonable?
Will the increased capacity in the marketplace, created by the project itself, impact prices?
Investment Appraisal and Risk
Appraisal Methods: ARR, PBP, NPV, IRR
ROCE is similar to ARR but is measured after business is performed. ROCE is useful when comparing
to industry averages since ARR and ROCE are linked. ARR is affected by competing investments.
PP gives crude estimate of risk. Other risks are involved such as less demand for a product. Other
systematic approaches are available – research? PP doesn’t help maximise wealth.
The risk of NPV is forecast level of sale is not accurate until the machine has been purchased. Fees
for surveys and analyses of market must be paid, and advertising is required.
• Identify and evaluate sources of finance in the context of implications for capital
structures and returns to shareholders
• Identify and critique ways of returning value to shareholders
• Identify and evaluate methods to value a firm.
Part C
A term loan is offered by banks and other financial institutions tailored to business needs. The time
period, repayment terms and interest rate are set.
Loan notes are long term finance divided into units and investor can purchase a number of units.
Loan notes can be redeemable or irredeemable. Loan notes are traded on the Stock Exchange. They
fluctuate according to business fortunes and movements in interest rates.
Level of borrowing based on factors such as:
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Risk: Risk-averse investors will be prepared to take more risk only where there are higher
rates of return
Returns: There will be lack of additional share capital when receiving poor returns. They may
encourage managers to try increase their returns by exploiting higher financial gearing.
Control: Issuing more shares may results in dilution of control, loan capital viewed as better
option.
Flexibility/Ease: Loan capital can be raised quicker than share capital, no delays in decision
making. Useful for fast-changing environment.
Debt capacity: Too high borrowing will eliminate capacity for future borrowing.
Exerting Financial Discipline: A business that’s highly geared must make substantial interest
payments and capital repayments can exert powerful financial discipline over managers.
NOTES
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Initial investment is wrong, check incremental, cash and profit discrepancies
Tax rate applies to cash flow from operations
Composite tax? What is it? Don’t use it
Working Capital:
30 marks for calculations, 10 for reasoning and advice
Sources of Finances
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Cost is a percentage
Relate to the context of the project
Watch lectures
Independent research and thought
Understand implications and structure of funding
Difficult to do calculations as it requires certain assumptions. Explore using proportions of
different funding
Relate to the context of stock exchange listed company
Google ‘Consequences of using different types of sources of funding on projects’ etc
Pwc, KPMG funding
Part B:
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Multiply certainty equivalent to get cash flow, then discount values
Not ENPV
Vidcast 4.1