Strategic Financial Management And Capital Budgeting Techniques In Essay.

To undertake Project Wolf, factory space which is currently generating rental income will need to be used for the project. The rental income, which would not have been expected to change over the five-year period, is $75,000 per annum. This project will take the company in a new direction appealing to a different type of customer.

Additional financial information:

• Corporation tax is paid at a rate of 20% and tax is payable one year in arrears.
• The weighted average cost of capital is 10% and, unless otherwise stated, cash flows occur at the end of the year to which they relate.
• A straight line method of depreciation at a rate of 20% is applied to all noncurrent asset

Prepare a report to the Directors of AYR Co. which includes the following.

1. A calculation of the Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period for projects Aspire and Wolf. Detailed calculations should be included as an appendix to the report. All cash flows should be rounded to  the nearest $. 30%
2. Analysis and evaluation of the investment project options as follows:
3. A recommendation regarding which project (if any) to undertake;
4. Justifications for your recommendation including an evaluation of the investment appraisal techniques used in task 1 above.

A summary of other factors that should be considered and information that may be needed prior to making a final decision. 30%

3. A discussion of the two sources of finance being considered by the board of AYR Co. Your report should include:
4. A description of Equity and Debt.
5. An explanation of the costs of each source of finance.

An analysis of the effect the selection of the source of finance may have on AYR Co.’s weighted average cost of capital.

1. An assessment of the impact of the selection of finance on current and potential shareholders and lenders.

Strategic financial management is a set of policies and rules which is made by the business to meet the corporate goals of the business. It helps the business to manage all the internal and external operations of the business in better way. The financial strategies of a business are prepared and managed by the financial manager of the company. The base is prepared firstly to make better strategies if the business. A base is prepared on the basis of the historical data of the company and the future foresting of the business (Madura, 2014). The main motto behind these strategies is to improve the overall position of the business. The ratio analysis, trend analysis, capital structure, capital budgeting, vertical analysis etc are some of the methods which are applied by the financial manager of the company to recognize the overall position of the business.

In the given case study, a company, AYR limited is thinking to opt a proposal from the two available projects in the market. The study and this report focus on the best proposal for the business. the name of the projects of AYR limited are Aspire and Wolf which are offering the different cash inflows of the business and the associated cash outflows of the projects are also different. Though, the requirement of the initial investment is similar in both the projects. In the report, capital budgeting techniques have been applied on both the projects to identify the best project for the business in order to improve the return of the business and get higher return than the WACC position of the business. Along with the application of the capital budgeting, capital structure of the business has also been studied. The main motto of calculating the cash flow position of the business is to identify that whether the business would be profitable for the shareholder and how much changes would occur in the capital structure of the business (Kurth, 2013).  

Part A: Capital budgeting tools:

It is required for a business, investors or the government that how much return would be got after investing into a particular project for a particular period of time. Capital budgeting tools are one of methods to measure the return and the other factors related to a project. The process of capital budgeting is applied by the business to recognize the different outcome related to the project and make decision that whether the project must be accepted by the business or not (Lord, 2007).

Part A: Capital budgeting tools

The main tools of capital budgeting method is net present value, which evaluated the present value of future cash outflows and inflows of the business and measure the profitability level of the project, internal rate of return which identifies the total return from the project in terms of %, payback period which recognizes the total time in which the payment made by the investors would be got back etc. Each of the capital budgeting tools is applied by the financial manager of the comapny to make different decisions. In case of AYR limited, the capital budgeting techniques have been applied on both the projects to identify that which project is best for the company (Lumby and Jones, 2007). The calculations and analysis of all the projects are as follows:

Net present value:

Net present value (NPV) is one of the most used methods of capital budgeting which evaluated the present value of future cash outflows and inflows of the business and measure the profitability level of the project. The outcome from the NPV calculations is evaluated on the basis of the NPV figure (Lee and Lee, 2006). If the net profit level is positive then it is profit sign and it explains that the project must be accepted by the business otherwise vice versa.  

(Kurth, 2013)

On the basis of the above calculations on the “Aspire” project of the company, it has been found that the total cash outflow’s present value is $ 23,90,000 and the cash inflow’s present value is $ 28,71,267. It explains that the total present value of the project is $ 4,81,267. It explains that the NPV of the project is positive and thus the project must be accepted by the business (Krantz, 2016).

Further, the “Wolf” project of the business has been studied. The NPV tool has been applied on the project and the calculation and analysis of the project is as follows:

On the basis of the above calculations on the “Wolf” project of the company, it has been found that the total present value of the project is $ 7,34,464. It explains that the NPV of the project is positive and thus the project must be accepted by the business.

The calculations on both the project lead to the conclusion that the NPV position of project Wolf is higher and thus the project “Wolf” is better choice for the purpose of investment by AYR limited.

Net Present Value

Internal rate of return:

Internal rate of return (IRR) is one of the most used methods of capital budgeting which depicts about a % where the NPV of the project would be zero. This technique ultimately explains that how much return would be got by the business from the project. The outcome from the IRR calculations is evaluated on the basis of the WACC rate of the business (kinsky, 2011). If the IRR rate is higher from the WACC rate of the business then the project must be accepted by the business otherwise not. The calculations of IRR on both the projects are as follows:  

On the basis of the above calculations on the “Aspire” project of the company, it has been found that the internal rate of return of the project is 16.81% and according to the given case, the cost of capital of the business is 10%. It explains that the ISs rate of the project is higher than the cost of capital. It explains that the project must be accepted by the business.

Further, the “Wolf” project of the business has been studied. The IRR tool has been applied on the project and the calculation and analysis of the project is as follows:

On the basis of the above calculations on the “Wolf” project of the company, it has been found that the internal rate of return of the project is 22.32% and according to the given case, the cost of capital of the business is 10%. It explains that the ISs rate of the project is higher than the cost of capital (Kaplan and Atkinson, 2015). It explains that the project must be accepted by the business.

The calculations on both the project lead to the conclusion that the IRR position of project Wolf is higher and thus the project “Wolf” is better choice for the purpose of investment by AYR limited.

Payback period:

Payback period is capital budgeting method which depicts about a total time period in which the invested amount and the cash outflow related to the project would be got back by the investor (Ross, Westerfield, Jafee and Kakani, 2008). The outcome from the payback period calculations is evaluated on the basis of the total time period of the project. The calculations of payback period on both the projects are as follows:

(Reilly and Brown, 2011)

On the basis of the above calculations on the “Aspire” project of the company, it has been found that the total payback period of the project is 3.63 years. It explains that the total time period of the project is 5 years which is higher than the payback period. It explains that the project must be accepted by the business.

Internal Rate of Return

Further, the “Wolf” project of the business has been studied. The payback period tool has been applied on the project and the calculation and analysis of the project is as follows:

On the basis of the above calculations on the “Wolf” project of the company, it has been found that the total payback period of the project is 2.83 years. It explains that the total time period of the project is 5 years which is higher than the payback period. It explains that the project must be accepted by the business (Ward, 2012).

The calculations on both the project lead to the conclusion that the payback period position of project Wolf is better and thus the project “Wolf” is better choice for the purpose of investment by AYR limited.

Part B: Analysis and evaluation:

Recommendation:

The calculations and the analysis on both the projects of the Ayr limited represents better position and returns from the market. However, it has been found that the return from the Wolf project is higher than the project Aspire. As well as, the payback period of Wolf is lower than the project Aspire. Further, on the basis of the internal rate of return of both the projects, it has been found that both the projects are getting higher return than the cost of capital. But on the basis of comparison study, the position of project Wolf is better.

Through the evaluation on each of the topic (such as net profit, return, time etc) it has been recognized that both the projects are good for the company. But in term of comparison in both the projects, project Wolf is better for the company.

Justification:

“Project Wolf” has been recommended to the AYR limited because of the wider concept and the wider area of project wolf. Such as in the case of net present value of the business, it has been recognized that the present value of the project is $ 4,81,267 and $ 7,34,464 in case of project Aspire and Wolf respectively (Radebaugh, Gray and Black, 2006).

Further, internal rate of return of the project Aspire is 16.81% and the internal rate of return of the project “Wolf” is 22.32% and according to the given case, the cost of capital of the business is 10%.  

Lastly, the payback period of the project Aspire is 3.63 years and the project Wolf’s payback period is 2.83 years. It explains that the performance of wolf is better than Aspire in all the terms (Weaver, Weston and Weaver, 2001).

Summary of other factors:

The financial factors such as profit, time, return etc are not enough for a business to make decision about the project of a company. The company must also focus on various economical, industrial, environmental factors etc to recognize the overall position of the project. These factors make it easier for the business to meet the goals of the company and achieve the growth in the market (Zabarankin, Pavlikov and Uryasev, 2014).

The AYR limited is also recommended to look over these factors to improve the position of the business such as the technology advancement in the industry, durability of the project, demand of the customers etc. on the basis of the non financial factor performance on both the projects, it has been identified that the performance of both the projects are similar in the industry and though the financial position of wolf is better, so the investment must be done in project wolf.

Funds are required for each of the business to run the business. If the proper funds are not available for a company than it becomes tough for the business to continue in the market. There are various choices through which a business could raise the funds easily such as through issuing the equity, debt, loan from financial institution, retained earnings etc. (Weston and Brigham, 2015)

Equity and debt:

The main source of funds of a business is equity and debt. Both of them are the external sources to raise the funds in a business. In case of equity shares, the funds are raised  by the business through selling the ownership in the market. The owners of the equity shareholders are eligible to take the share in the profit of the company which is distributed them on the basis of dividends (Palicka, 2011). On the other hand, the debentures are long term borrowings of the company. The debts are issued by the company with a note that the debt amount would be repaid by the business. Against the debt amount of the debt holders, interest amount is paid by the company.

Cost of each sources:

The business is required to pay some amount against the finds to the investors who have invested their money in the business. Cost of equity and debt are as follows

Cost of equity:

Cost of equity represents the total amount which has been given as dividend amount to the shareholders of the business. The cost of equity of a business is always higher than the level of cost of debt because of the fact that the risk in the equity investment of a business is higher. The cost of equity represents the debt amount of the company (Zimmerman and Yahya-Zadeh, 2011).

Cost of debt:

Cost of debt represents the total amount which has been given as interest amount to the debt holders of the business. The cost of debt of a business is always lower than the level of cost of equity because of the fact that the risk in the debt investment of a business is lower.  The cost of debt represents the finance cost of the company (Peterson and Fabozzi, 2002).

Analysis effect:

The analysis study has been done on the capital structure of the business. In current scenario, the equity and debt weight of the company is 52.63% and 47.37%.

On the basis of the given weight of the company, the WACC of the business has been evaluated along with an assumption that the interest rate of the debt of the company is 9%. The cost of equity and cost of debt of the company is 12.52% and 7.20%. It explains that the debt level of the company is lower (Phillips and Stawarski, 2016). Thus the company should raise the debt amount more.

In order to invest into the Wolf project, the business could raise the funds through debt fund. In order to improve through debt funds, the  share of equity and debt are 49.69% and 50.31% and the cost of capital of the business is 9.84%.

So, the improvement in the debt funds would manage the gearing position and reduce the cost level of the business.  

Impact on current and potential stakeholders:

In case, the company raises the funds through debt than it would reduce the cost of the business along with the reduction in the total cost of the equity of the company. However, the cost of debt of the company would be improved (Schlichting, 2013). Individual shareholder would not be affected because of these changes into the company.

Conclusion:

To conclude, AYR co should invest into the project Wolf. The investment into the project wolf would offer higher return to the business along with the great market position. Further, it is also suggested to the business that the debt level of the company is lower. Thus the company should raise the debt amount more so that the financial gearing position and the cost level of the company could be managed.

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