指导英国财务和管理会计termpaper：Financial and Management Accounting

Section 1

1. Calculate lilyhammer’s existing WACC on the basis of the information provided.

 

P0=25-1.46=23.54  g=8%  (1+g)4*1=1.36

 

 

4% redeemable debentures 

time CF Discount @ 5% factors PV Discount @ 10% factors PV

t0 -94 1 -94 1 -94

t1-5 4 3.546 14.184 3.169 12.676

t5 100 0.784 78.4 0.621 62.1

NPV 　 　 -1.416 　 -19.224

 

Pre tax Interest rate (Kd) NPV

5.00% 1.416

6.75% 94

10.00% 19.224

Post-tax Kd

 

           4.5%

Weighed Average Cost of Capital 

Equity     14.24%           23.54*130M=3060.2M

Debenture 4.5%             125M*94/100=117.5M

Total 3177.7M

 

WACC= (14.24%*3060.2+4.5%*117.5)/3177.7=（435.77+5.29）/3177.7=13.88%

 

2. Describe the difficulties that companies that companies such as Lilyhammer might encounter when attempting to calculate their WACC.

 

The difficulties could be summarized as follow: using wrong discount rate and growth rate (g).

The cost of capital (hurdle rate) is the cost of funds that a company raises anduses, and the return that investors expect to be paid for putting funds into thecompany and therefore is the minimum return that a company must make onits own investments to earn the cash flows out of which investors can be paid their return (pre corporate tax). The cost of capital is an opportunity cost of finance – it is the minimum returnhat investors require. If they do not get this return, they will transfer some orall of their investment elsewhere. So when shareholders invest in a company the returns they can expect must be sufficient to persuade them not to sell some or all of their shares and invest somewhere else (general discussion the consequences of using wrong discount rates). Also, The yield on investment is the opportunity cost to the investors of not investing elsewhere. Thus current market prices must be used to establish the costs of the various elements of long-term capital. Nominal (historical) valuesare irrelevant. Market values also reflect the importance (i.e., weighting) ofthe different forms of finance.

 

3. Critically evaluate the suggestions of the finance director, the managing director and the production director.

Finance director

In the consideration of the return rate of the project, the rate can not be lower than the WACC, so that Finance directors should fully considered the return rate. 

 

Managing director

For the position of the management director, it should pay attentions on the management cost which is also related the cost of the project, the costs are associated with the travelling costs and office expenses.

 

Production director 

In a position of the production director, he should fully be considered on the cost of the project such as the direct materials and overheads cost. 

 

 

Section 2

Q3 Question 3

Financial leverage is the degree to which a company uses fixed-income securities such as debt and preferred equity. The more debt financing a company uses, the higher its financial leverage. A high degree of financial leverage means high interest payments, which negatively affect the company's bottom-line earnings per share.

 

Equity capital 

This figure represents assets minus liabilities. There are some businesses that are funded entirely with equity capital (cash written by the shareholders or owners into the company that have no offsetting liabilities.)  Although it is the favored form for most people because you cannot go bankrupt, it can be extraordinarily expensive and require massive amounts of work to grow your enterprise.

 

Debt capital 

This type of capital is infused into a business with the understanding that it must be paid back at a predetermined future date.  In the meantime, the owner of the capital (typically a bank, bondholders, or a wealthy individual), agree to accept interest in exchange for you using their money.  Think of interest expense as the cost of “renting” the capital to expand your business; it is often known as the cost of capital.

Financial risk is the risk to the stockholders that is caused by an increase in debt and preferred equities in a company's capital structure. As a company increases debt and preferred equities, interest payments increase, reducing EPS. As a result, risk to stockholder return is increased. A company should keep its optimal capital structure in mind when making financing decisions to ensure any increases in debt and preferred equity increase the value of the company.

 

 

Question 4

a) Compute the payback period of the project

Payback period 　 　 　 #p#分页标题#e#　 　 　

　 Cash flow Cumulative cash flow

Year Q R S Q R S

0 -150,000.00 -180,000.00 -200,000.00 -$150,000.00 -$180,000.00 -$200,000.00

1 60,000.00 80,000.00 90,000.00 -$90,000.00 -$100,000.00 -$110,000.00

2 60,000.00 60,000.00 70,000.00 -$30,000.00 -$40,000.00 -$40,000.00

3 40,000.00 50,000.00 60,000.00 $10,000.00 $10,000.00 $20,000.00

4 30,000.00 40,000.00 30,000.00 $40,000.00 $50,000.00 $50,000.00

5 　 20,000.00 20,000.00 　 $70,000.00 $70,000.00

6 　 　 10,000.00 　 　 $80,000.00

　 　 　 　 　 　 　

Payback period Q 2.75 　 　 　 　

　 R 2.80 　 　 　 　

　 S 2.67 　 　 　 　

 

 

b) Compute the net present value(NPV) for the project.

　 　 Rate NPV 　 Rate NPV 　 Rate NPV

　 -150,000.00 1.00 -150,000.00 -180,000.00 1.00 -180,000.00 -200,000.00 1 -200,000.00 

1 60,000.00 1.10 54,545.45 80,000.00 1.10 72,727.27 90000 1.1 81,818.18 

2 60,000.00 1.21 49,586.78 60,000.00 1.21 49,586.78 70000 1.21 57,851.24 

3 40,000.00 1.33 30,052.59 50,000.00 1.33 37,565.74 60000 1.331 45,078.89 

4 30,000.00 1.46 20,490.40 40,000.00 1.46 27,320.54 30000 1.4641 20,490.40 

5 -10,000.00 1.46 -6,830.13 20,000.00 1.61 12,418.43 20000 1.61051 12,418.43 

6 　 #p#分页标题#e# 1.77 -10,000.00 1.61 -6,209.21 10000 1.771561 5,644.74 

7 　 　 　 　 　 　 -10000 1.771561 -5,644.74 

NPV 　 　 -2,154.91 　 　 13,409.54 　 　 17,657.14 

　 　 　 Project Q 　 　 Project R 　 　 Project S

 

c) Calculate the internal rate of return for each project.

cash flow

Year Q R S

0 -150,000.00 -180,000.00 -200,000.00 

1 60,000.00 80,000.00 90,000.00 

2 60,000.00 60,000.00 70,000.00 

3 40,000.00 50,000.00 60,000.00 

4 30,000.00 40,000.00 30,000.00 

5 　 20,000.00 20,000.00 

6 　 　 10,000.00 

 

Internal rate of return

Q 12%

R 15%

S 16%

 

 

d) Discuss the advantages and disadvantages of the pre-mentioned three methods for investment appraisal.

 

Advantage for the IRR: 

There are two advantage of the IRR, they are time value of money and easy to understand.

Firstly, unlike some other capital budgeting techniques, like the accounting rate of return and payback period method, internal rate of return considers the time value of money. Financial theory states that the earlier a company receives a payment for the investment, the more that payment is worth. Internal rate of return reflects this concept by assigning early cash payments a higher dollar value than cash payments that occur in future years. This gives the firm a more realistic sense of what the investment is worth. Accounting rate of return and payback method, on the other hand, may overestimate the investment's value.

Secondly, ultimately, corporate investment decisions often are made by executives who aren't experts in finance. Some capital budgeting techniques, like the net present value method, may be more difficult for non-financial employees to understand or interpret. Most executives are familiar with interest rates, however, which are considered in the internal rate of return method.

 

There are two disadvantages of the IRR, interest rate issues are conducted in the calculation of the IRR.analysts predictions are often incorrect for very risky investments and investments with a long time frame. If management doesn't have a good investment alternative at the estimated interest rate or chooses not to reinvest the funds, the internal rate of return figure will be incorrect.

 

Advantages of payback period are:

1. Payback period is very simple to calculate.

2. It can be a measure of risk inherent in a project. Since cash flows that occur later in a project's life are considered more uncertain, payback period provides an indication of how certain the project cash inflows are.

3. For companies facing liquidity problems, it provides a good ranking of projects that would return money early.

Disadvantages of payback period are:

1. Payback period does not take into account the time value of money which is a serious drawback since it can lead to wrong decisions. A variation of payback method that attempts to remove this drawback is called discounted payback period method.

2. It does not take into account, the cash flows that occur after the payback period.

 

Advantage of the net present value:

1. The biggest advantage to net present value is its dollar-to-dollar analysis. A dollar today is not worth the same amount as a dollar tomorrow. When taking this concept several years into the future, it is easy to see why net present value has an advantage for project selection. Discounting the future cash flows for each project under review allows a company to compare the costs spent today to the potential dollars the project will bring in, in current dollar value.

Cost of Capital Comparison

2. Most companies use external funds when starting large projects. The cost of capital represents the interest a company pays on borrowed funds. Net present value includes a company's cost of capital into the review stage. Companies can also use different cost of capital figures for different projects. For example, creating different mixes of debt and equity funds with slightly different cost of capital figures increases the net present value advantages.

 

Disadvantages of the net present value 

1. Net present value calculations require copious amounts of information when reviewing multiple projects. The inability to gather all necessary information or accurate information can weaken this analysis tool. Additionally, multiple project options with different information may be difficult to analyze. For example, one option may increase sales while another deceases costs. Comparing the information from these two options may result in different answers based on the gathered information.

2. Project analysis may require a different tool so a company can make an informed decision. Other analysis tools include payback period or internal rate of return. These tools may provide a better result than net present value. It is up to the company's management team to decide which tool provides the best option for selecting an option from multiple projects. A financial analyst or other employee can often provide insight into the best tool to use.