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BFM205 Business Finance - Aston Business School

Learning Outcome 1: Examine the financial problems faced by firms in their financial and economic environment

Learning Outcome 2: Analyse the financial problems faced by firms and provide an appropriate solution

Learning Outcome 3: Evaluate through the use of financial tools an effective solution to a problem

Learning Outcome 4: Evaluate appropriate financial theory to provide an effective solution to a problem

Task Description:

Task 1

Beval Ltd wishes to expand its products and is interested in buying a new piece of machinery for £500,000. It has estimated that in the first year it should be able to manufacture 50,000 units at a selling price of £10 per unit; in the second year it should increase to 55,000 units at a selling price of £10.50 per unit; the third year 52,000 units at a selling price of £9 per unit; and in the final year it would be 40,000 units at a selling price of £8 per unit. In the first year the variable costs are estimated to be £5 per unit, inflating at 3% per annum after that. Fixed costs are £50,000 in year 1, increasing at 2% per annum. Corporation tax is 19% payable in the year. The residual value of the machinery is estimated to be £100,000 at year 4 prices. Cost of capital is 9%. Beval Ltd has a target payback period of 3 years, and a target Average ARR of 15%.

a) Calculate the Net Present Value (NPV) of the investment to the nearest £1,000; the Internal Rate of Return (IRR); the Payback; and the Accounting Rate of Return (ARR) based on average investment. Recommend, with reasons, whether or not the company should proceed with the investment on financial grounds.

b) Compile a report on the superiority of Net Present Value (NPV) for Beval Plc over other investment appraisal techniques. (There is a word limit of 350 words for this part b of the question.)

Task 2

Angus Johnson has inherited some money and is interested in investing in the Stock Market. He is lacking knowledge in the best approach to undertake to be a successful portfolio holder and has turned to you for advice.

Required:
Write an email to Mr Johnson, where you critically discuss the methods available to him to make investment choices. Draw on academic literature to evidence your arguments.

Your email should include explanations of unsystematic and systematic risk; the method to use to decide whether or not to take on a new investment in an undiversified portfolio; the method to use to decide whether or not to take on a new investment in a diversified portfolio.
(There is a word limit of 450 words for this question.)

Task 3

Consign Plc is considering expanding and therefore wants to invest in a new piece of machinery costing £1 million. In order to do this, it will take out a long term bank loan at an interest rate of 8%. Ignore issue or administration costs.

Currently it has 2 million shares in issue at a share price of £3.20. It has a beta value of 1.126. The risk free rate of return is 4% and the market premium is 7%.

It also has 500,000 6% preference shares, with a nominal value of £1 and a share price of £0.86. Its 7% irredeemable bond has a book value of £2 million, which is at par. The current tax rate is 20%.

Requirements:

a) Calculate the weighted average cost of capital (WACC) of Consign Plc in the following circumstances:
i) Before the new bank loan is issued;
ii) After the new bank loan is issued.

b) Discuss, with reference to capital structure theory, the validity of the assumption that reducing debt will reduce the company's cost of capital. You should also refer to the scenario and to your calculations in part (a) to support your arguments.
(There is a word limit of 450 words for this part b of the question.)

Task 4

Sherry Plc is an international conglomerate, and the directors are looking at taking over a competitor, a smaller company Dante Ltd.

The assets of Dante Ltd have a book value of £526,000 however the non- current assets are undergoing a revaluation. The preliminary findings indicate that they will actually be worth £45,000 less than the net book value. In addition, due to the current economic situation, some of its customers are having cash flow problems, and the Finance Director has stated that about £34,000 of receivables will have to be written off.

Sherry Plc has a P/E ratio of 10. Dante Ltd does not have its own P/E ratio but the directors believe it would be similar to that of Sherry Plc.
Dante Ltd has been asked to predict the future free cash flows of the company. It has estimated the current level of free cash flow for valuation purposes is £112,000. It is predicted that will increase by 1% in the coming year; 2% for each of the two following years; thereafter it will increase by 1% each year.

Its current Profit After Tax for the year ended 31st December 2021 is £108,000.

The cost of capital of Dante Ltd is 11%. It has issued share capital of 0.5 million shares, and a long term bank loan of £50,000.

Required:

a) Calculate three alternative equity valuations for Dante Ltd based on the above information. State which value you would recommend if the company was facing a takeover situation and discuss the reasons for your choice.
(There is a word limit of 200 words for this part a of the question.)

b) Discuss the reasons why Sherry Plc may choose to fund the takeover by raising debt rather than issuing equity via a rights issue.
(There is a word limit of 100 words for this part b of the question.)

Task 5

Penguin plc had suffered operating losses between 2017 and 2018, during which time the company had to stop paying dividends. A new management team was appointed who led a restructuring programme and introduced some new investment initiatives. As a result of this the company returned to profitability in 2020.

The year ending 31st March 2021 saw another profitable year as fortunately it was in a sector not negatively impacted by the pandemic, in fact the profits were an increase on the 2020 results. The board of directors have met to discuss the results for the year ended 31st March 2021, they have differing views as to how to maintain profitability and how, or whether, dividend policy has an impact:

• The Marketing Director was of the opinion that the company's results and standing in the marketplace are the significant factor and that dividends are unimportant.

• The Chief Executive is focused on the need to be able to undertake investment opportunities which will maintain and improve profit, particularly given the company's history whereby new investment initiatives helped turn the company around into a profitable enterprise. She considers retaining funds for investment the priority and it is only after the financing of such projects has been undertaken should the surplus be paid out to shareholders.

• The Finance Director is of the opinion that dividend can impact the share price of the company and therefore a stable dividend policy should be introduced as soon as possible.

Requirement:

Critically discuss the arguments of each of the 3 directors using the theory of dividend policy.
What would your recommendation be to the board of directors as to the appropriate dividend policy to pursue?
State any other information you might require in order to refine your answer.

Task 6
Critically reflect on two key learnings from the module, which could be drawn from the uses and the limitations of accounting information and/or accounting techniques for management purposes.

You should include specific examples and illustrations to support your reflection. These examples could include those arising from the business simulation activity, the module materials, your wider reading, and any relevant personal experiences.

It is expected that you will engage with relevant reflective practice literature to help structure and analyse your reflections. In addition, the following article provides a succinct summary of some of the basic reflective practice models:

Rolfe, G. (2014). Big Ideas: Reach, touch and teach, Terry Borton. Nurse Education Today, 34, pp488-489