LONDON SCHOOL OF BUSINESS AND FINANCE

Master in Finance and Investments

To Discursive group forum

From Merlia Thandiwe Kumdana - I1071307

Course Name Business and Financial Analysis (UTIU Finance 25th April 2022)
(Group 3)
Assignment # Unit 4 3 Questions

Student Signature M.T.K

 a) Determine the relevant cash flows to be used in the investment evaluation.

The relevant cash flows are future, incremental cash flows arising from the decision being made. This means that the cash flows are
only relevant if they are to be incurred in the future and incremental costs. Relevant costs are used for taking an investment decision

In this scenario, the expected project investment cost of £3,500,000 is a relevant cash flow as it is an initial investment, which will be
committed to the project

The after-tax cash inflows estimated at £800,000 per year for the duration of the project is also a relevant cash flow as it is a future
cash inflow

An opportunity cost of expansion in the UK of £725,000 is also a relevant cash flow as that is the income foregone by choosing the
investment in Turkey

The cost of £50,000 for a visit to Turkey to evaluate the location and for meetings with the Turkish investment authority will be a
relevant cost since it’s a future cost but had it been that the process was already undertaken then it would have been irrelevant

b) i. NPV

Period (Year) 0 1 2 3 4 5 6 7
Discount Rate 20%
Discount Factor 1 0.833 0.694 0.579 0.482 0.402 0.355 0.279
Undiscounted Cash 800,00 800,000
flow - 3,500,000. 0.00 800,000. 800,000. 800,000. 800,000. 800,000. .
Present Value 666,40 555,200. 463,200. 385,600. 321,600. 284,000. 223,200
 0.00 00 00 00 00 00 .
Total P.V Cash 2,899,200.
inflow 00
-
Net present Value 600,799. (Reject)

ii. CAPM

The Capital Asset Pricing Model (CAPM) is a model that describes the relationship between the expected return and risk of investing
in a security. It shows that the expected return on a security is equal to the risk-free return plus a risk premium, which is based on
the beta of that security. Below is a calculation of the CAPM

E(ri)=Rf + βi (E(rm) – Rf )

where: Rf = the risk-free rate, and E(rm) = the return from the market

2%+(6.5%-2%)*1.2

7.40%

From the scenarios above, we see that the NPV is minus 600,799 as such the project is not worthwhile taking as it gives negative
returns, which is a loss. Though just taking the 800,000 income in 7 years might seem to bring 5.6Million but taking into account the
time value of money the project is not worth investing besides the Expected rate of return which can be equal to the risk of investment
is calculated to be 7.4% which is above the market return
c) Critically evaluate the choice of funds that the CFO wishes to use against other possible options and critically discuss any
other issues that are applicable in this scenario.

Retained earnings are the portion of profits reserved for reinvestment in the company rather than distributed as dividends.

This is a cheap source of money unlike to Debt Financing and Equity Financing, since there are no interest payments or fees.

Other benefit of using retained earnings is that they are flexible and fast as there are no conditions on how you spend the money, and
there's no waiting for a lender to process your request.

Retaining earnings can increase future earnings as spending can make the company more profitable since unlike loan, interest
payments can`t eat future profits.

However, it has its setback mainly to the shareholders when Managers resolve to spend the money simply because it's there, and
thereby waste it. So if shareholders think you're relying too much on earnings or not using the money effectively, they may feel
cheated of their dividend income. Problems may arise as well when there is need to seek for outside capital down the road arise
since there may not have developed the relationships with investors who may secure funding.

Shareholders may also give more pressure to issue large dividends instead of reinvesting earnings.
Nevertheless, when returned earnings are not available, Debt Financing can substitute that, as it involves getting a loan and pay
interest as cost. Debt Financing can be seen as less risky to some investors since if a company experiences financial hardship, the
order of repayments are payroll, taxes, loans and then equity investors are paid the remaining amount, if any.

If the entity fears for paying more on interest, it can however sought for Equity Financing as it gives some level of ownership in the
company for the investment. With this Business owners risk losing the company to a takeover, if an equity owner is able to get the
majority of shares through investment.

Another way is to go for the expansion in the UK since it has a benefit of £725,000 and forget about the investment in Turkey as it
has negative returns.

Reference:

Fridson, M.S. and Alvarez, F. (2011) Financial statement analysis: A practitioner’s guide. (4th ed.) Hoboken: Wiley. (Chapters 13-
14). Available at: https://ereader.perlego.com/1/book/1012809/5 (Links to an external site.)

Atrill, P. and McLaney, E. (2018) Accounting and finance for non-specialists. (11th ed.) Hoboken: Pearson. (Chapter 10). Available
at: https://ereader.perlego.com/1/book/859641/1

Open Tuition, ACCA Financial Management (FM) Notes, Chapter 7 & 8, (September 2022 – June 2023 exams)