Financial Strategy 001 RESIT Case Study

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Financial Strategy 001 – RESIT Case Study

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Introduction

This study is conducted to analyze the tools and techniques which can be helpful in better assessment for the company in investment for any projects. Investment appraisal tools and techniques help management in better decision-making for investment purposes in new projects for their business activities.

Under this study, a case study is taken for analysis of the impact of the purchase of Van for Barcha Ltd where NPV, ARR, and payback method is used for identified the profitability of decision for purchasing VAN. Further, in this study, a significant source of finance is identified which can impact the financial decision as well as the financial performance of the company. During the study, Working capital management is also used for a better understanding of the flow of duns and also the availability of working capital for business activities. Working capital management also helps in better understanding of operation liabilities which a company or business needs to repay in a specific period to manage the overall workflow of business activities.

The overall assignment includes principles and theories of Capital budgeting, capital structuring, and working capital management which overall provide a broad image of the impact of Van purchase on financial stability and the future benefits for the company.

PART A

01.Investment Appraisal Tools and Techniques

PAYBACK Period

The payback period method is a technique of capital budgeting that can be helpful in better identification of the overall business period in which a business can generate revenue equal to its initial cost of investment (Bierman, J.R. and Smidt, S., 2012). The payback period portraits the Break-even point of revenue generation on which business can be written off their initial outlay. The payback method assists management in identified the estimated year they need to take to achieve them no profit no loss stage from the purchase of VAN for their business activities.

Payback Period

Year

Cash flow

Cumulative Cash flow

Initial Investment

-£ 20,000.00

-£ 20,000.00

1

 £ 6,500.00

-£ 13,500.00

2

 £ 7,500.00

-£ 6,000.00

3

 £ 7,500.00

 

4

 £ 8,250.00

 

5

 £ 8,500.00

 

Here Company Completed two years and also they have a £1,500 amount which is required to be recovered from revenue generation activities of the company so that company can fulfill the cost of the project from their business activities(Siziba, S. and Hall 2019).

Payback Period

=

Completed year

+

Remaining income for Cost of project

Annual Income of Next year

Payback Period

=

2

+

6,000

=

2.80 Years

7,500

               

Here Payback Period for this project is 2.80 in which the company can set off the cost of the project from their revenue earn from operations.

Accounting Rate of Return

This method assists management or company in better assessing the average rate of return of their investment projects. This is the rate of return that defines the operational rate of return which is achievable through the operational activities of the business (RAWAT et. Al. 2018). Accounting rate of return provides an estimated rate which is achievable from the project in which company i9nvestned their capital employed so IF ARR is higher than the cost of capital then relevant investment project can be beneficial for the company is another factor are constant.

Accounting Rate of Return

ARR

=

Average Net profit

X100

Average Investment

ARR

=

£ 2,625.00

X100

£ 10,000.00

ARR

=

26.25%

Here for Barcha Pty Ltd Cost of Capital is 5% and the company is earning a profitable rate of 26.25% which is approx. 21.25% higher than the cost of capital for the project. These stats indicate that the project is favorable on the ground where other things or factors in the environment are constant for the investor.

Net present Value

Net Present value is the method that helps in the understanding of net cash flow from the project for better decision-making of investors in the project. Net Present value includes cash outflow from Initial investment operating loss and Cash inflow from salvage value and operating income throughout the life of the assets(Kengatharan, and Nurullah, 2018). NPV helps management in understanding the net flow from the project so that they can invest their fund and NPV also assist in the selection of the most profitable project in between many projects based on Net cash Inflow and outflow.

Net Present Value

Particular

 Amount

   

Initial Investment for VAN

-£ 20,000.00

   

Net Cash Flow ( PV)

 £ 11,610.00

   

Net Cash Flow From VAN Purchase

-£ 8,390.00

Particular

I

II

III

IV

V

Total

Cash Inflow from operation

 £ 6,500.00

 £ 7,500.00

 £ 7,500.00

 £ 8,250.00

 £ 8,500.00

 £ 38,250.00

Less- Cash Outflow

 £ -

 £ -

 £ -

 £ -

 £ -

 £ -

Profit From the year

 £ 6,500.00

 £ 7,500.00

 £ 7,500.00

 £ 8,250.00

 £ 8,500.00

 £ 38,250.00

Less :- Depreciation

-£4,000.00

-£4,000.00

-£4,000.00

-£ 4,000.00

-£ 4,000.00

-£ 20,000.00

Profit Before Tax

 £ 2,500.00

 £ 3,500.00

 £ 3,500.00

 £ 4,250.00

 £ 4,500.00

 £ 18,250.00

Tax @ 50%

 £ 1,250.00

 £ 1,750.00

 £ 1,750.00

 £ 2,125.00

 £ 2,250.00

 £ 9,125.00

Profit After tax

 £ 1,250.00

 £ 1,750.00

 £ 1,750.00

 £ 2,125.00

 £ 2,250.00

 £ 9,125.00

Add :- Depreciation

 £ 4,000.00

 £ -

 £ -

 £ -

 £ -

 £ -

Cash flow from Activities

 £ 5,250.00

 £ 1,750.00

 £ 1,750.00

 £ 2,125.00

 £ 2,250.00

 £ 13,125.00

PVAF@5%

0.95

0.91

0.86

0.82

0.78

 

Net Cash Flow From project

 £ 5,000.00

 £ 1,587.00

 £ 1,512.00

 £ 1,748.00

 £ 1,763.00

 £ 11,610.00

As per the Net present Value Management of Barcha Pty ltd is facing financial cash outflow of -£ 8390 which indicates that the company will face cash outflow if they invested their capital employed in the purchase of VAN. If all things and factor are constant that NPV Suggest that management need to drop out the plan of Purchase VAN for their business activities.

02. Overall Suggestion of Project Plan

As per the analysis conducted Management needs to rethink three different aspects on which capital budgeting analysis is conducted. Here all the points are discussed below for the overall decision for investment in the purchase of VAN for Business activities of the company.

  • As per the Payback Period company can fulfill the cost of the project and also earn a profit of £ 18,250.00 which is a very high return from the project. As the project had a payback period of 2.80 so company had additional 2.2 years which can be helpful in profit generation for businesses. The payback period method suggested management of Barcha Ltd adopt the option of purchase the van for business activities of the company.
  • As per the accounting rate of return, Barcha Limited had a 26.25% rate of return from the project which enables the company to achieved a profit of 2,625 on average Investment of £10,000 from the VAN project? As per the analysis, the normal rate of return for the project can be 20% and the cost of the project is 5%. Here company had a higher return from the cost of the project so It is advisable that the management of the company should purchase VAN for their business activities.
  • As per Net present Value Barcha Limited facing Cash outflow from their business activities which makes a financial loss from the purchase of VAN to operate their business activities. Here as per the analysis, it is suggested that the company needs to drop out the plan of purchase of VAN for their business activities so that they can safeguard the business from financial loss in near future.

Overall Study suggested that the company can adopt the plan of purchase VAN for their business activities as the Payback period and ARR is in favor of the decision. Although Management needs to consider the results of NPV and also take preventive action so that they can overcome financial loss if any in near future.

03. Source of Income

Barcha Limited Has retain earnings of £4,000 which they can use as an Internal Source of funding. Management of Barcha Limited required additional Funding of £16,000 for the purchase of VAN for their business activities. The company needs to think about the external source of funds available in the market. Here some of the key Funding options are discussed which can be helpful in the generation of funding for business activities.

  • Bank Lending – Bank lending can be a useful tool in the scenario of Covid 19 as this is the most secured funding option which can easily be available in the market (Utami, 2019). The company can contact any of the financial institutions for their loan or funding requirement which can be fulfilled through various options of lending through a bank like Bank Overdraft, Cash Credit Limit, Chattel Mortgages, Hire Purchase, and another business loan.
  • Issue of Share and Bond – Company can adopt the option of Fresh Issue of shares and Bond in the Open market which can help in generating more funds with less risk of financial leverage on the profit of the company. Issue of share is the traditional option of funding in which the company issued fresh shares in the market and attracts more investors for investment in the company so that management can generate additional funds for their projects.

Part B

Working Capital Management

Working capital management is the tool that can be helpful for the management to manage overall current liabilities or any kind of short-term payment throughout their current assets. Working capital defines the amount which a business is required to run its business and operational activities on a routine basis (Chalmers, et.al. 2020). This helps management to identify the fund required which is necessary to meet up daily operational requirements of the company and also assist in managing overall current assets and liabilities so that company can smoothly operate its business activities.

Extract Balance Sheet at 30 June

 

2020

2019

£000’s

£000’s

Current Assets

   

Inventories

111

165

Trade Receivables

216

122

Bank

12

20

 

339

307

Current Liabilities

   

Trade Payables

97

156

Taxation

40

40

 

137

196

Working Capital

202.00

111.00

In this scenario, Barcha Limited compares net working capital with last year which helps them to understand that company had increased 100% working capital requirement as compare to last year. In 2019 Company had a working capital requirement of £ 111.00 which increased and became £202 in 2020. This is just double the liabilities that a company needs to settle down for its operational activities. The major reason of Increment in working capital is credit sales by the company which increased the amount of trade receivable in the market. Further, Company also amends their credit policies and provide payment to their creditors which again generate additional cash requirement for settling off creditors.

Conclusion

This study overall analysis the financial concepts of capital budgeting Working capital management and evaluate the source of income which can help for management to generate more initial funding for the business activity. Under assignment a case study is taken on which net present value favorite period and accounting rate of return is calculated for better understanding of tools and techniques of capital budgeting for taking decision of any investment of purchase proposal for company. In this assignment capital budgeting techniques are applied for a purchase of men for barcha limited where it is concluded that company should purchase van for the business activities for which the required source of fund which is discussed below in the study and at the end working capital management is evaluated so that management can understand their connect like this and over of working capital requirement to operate their business activities

References

  • Bierman, J.R. and Smidt, S., 2012. The capital budgeting decision: economic analysis of investment projects. Routledge.
  • Siziba, S. and Hall, J.H., 2019. The evolution of the application of capital budgeting techniques in enterprises. Global Finance Journal, p.100504.
  • RAWAT, B.S., Negi, P., Pant, P.C. and Joshi, G.C., 2018. Evaluation of energy yield ratio (EYR), energy payback period (EPBP) and GHG-emission mitigation of solar home lighting PV-systems of 37Wp modules in India. International Journal of Renewable Energy Research (IJRER), 8(1), pp.459-465.
  • Kengatharan, L. and Nurullah, M., 2018. Capital investment appraisal practices in the emerging market economy of Sri Lanka. Asian Journal of Business and Accounting, 11(2), pp.121-150.
  • Utami, E.S., 2019, October. Analysis Capital Structure on Indonesia Stock Exchange. In 2019 International Conference on Organizational Innovation (ICOI 2019)(pp. 686-690). Atlantis Press.
  • Chalmers, D.K., Sensini, L. and Shan, A., 2020. Working Capital Management (WCM) and Performance of SMEs: Evidence from India. International Journal of Business and Social Science, 11(7), pp.57-63.
  • Fehrenbacher, D.D., Kaplan, S.E. and Moulang, C., 2020. The role of accountability in reducing the impact of affective reactions on capital budgeting decisions. Management Accounting Research, 47, p.100650.
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