BA7002 Fincancial Resources Management Assignment Sample
Executive summary
The present report has shed light on the NPV analysis of the proposed project of Sparkly Ltd along with the sales price of the apartment and costs of financing that have been ascertained in this project. In the second question, the optimal allocation of the three investment projects of Evergreen activities Ltd has been ascertained in this project. The distinction between soft and hard capital rationing techniques has been developed in this report. In the last question, systematic risks and non-systematic risks of Vodafone and BT Group plc have been presented in this report. However, the risk premium of each share is analyzed in the concluding part of this report.
Question 1
(a) (i) NPV of the proposed project
| Discount rates | |
| Year | 5% |
| 0 | 1.00 |
| 1 | 0.95 |
| 2 | 0.91 |
| 3 | 0.86 |
| 4 | 0.82 |
| 5 | 0.78 |
| Particulars | Sales revenue (£) | Costs | Net cash flow (£` Million) | |
| Year 0 | -1400000 | -70000 | -1470000 | |
| Year 1 | 200000 | 10000 | 210000 | |
| Year 2 | 650000 | 32500 | 682500 | |
| Year 3 | 200000 | 10000 | 210000 | |
| Year 4 | 650000 | 32500 | 682500 | |
| Year 5 | 200000 | 10000 | 210000 | |
| Sparkly Ltd | ||||
| Cash flows (£ms) | Cash Flows | CCF | DCF @10% | PV (@10%) |
| Year 0 | -1470000 | -1470000.00 | 1.00 | -1470000 |
| Year 1 | 2,10,000.00 | -1260000.00 | 0.95 | -1200000 |
| Year 2 | 6,82,500.00 | 892500.00 | 0.91 | 809523.8095 |
| Year 3 | 2,10,000.00 | 892500.00 | 0.86 | 770975.0567 |
| Year 4 | 6,82,500.00 | 892500.00 | 0.82 | 734261.9588 |
| Year 5 | 2,10,000.00 | 892500.00 | 0.78 | 699297.1036 |
| NPV = | 18,14,057.93 | |||
| NPV = | Years | |||
| Net present value = (Summation of the total present value of a machine’s whole life) | ||||
Table 1: NPV of the proposed project
(Source: MS Excel)
(ii). 1. Estimation of the sales price of the apartment
| The sales price of the apartment | |
| Particulars | Amount (£) |
| First-year costs | £ 8,00,000.00 |
| Second years costs | £ 6,50,000.00 |
| Total costs in two years | £ 14,50,000.00 |
| Share of costs of financing total costs of the organization | £ 72,500.00 |
| Cost of financing | £ 15,22,500.00 |
| (Total costs of the company + Costs of financing) | |
| The selling price of a single apartment | £ 2,00,000.00 |
| Total profit earned from selling apartments | £ 20,00,000.00 |
| (Total number of apartments × profit earned from each apartment) | |
| profit earned in selling ten apartments | £ 4,77,500.00 |
| Profit earned from each apartment | £ 47,750.00 |
Table 2: Estimation of the sales price of the apartment
(Source: MS Excel)
(ii). 2. Cost of financing
| Cost of financing of Sparkly Ltd | |
| Particulars | Amount (£) |
| First-year costs | 800000 |
| Second years costs | 650000 |
| Total costs in two years | 1450000 |
| Share of costs of financing total costs of the organization | 72500 |
| Cost of financing | 1522500 |
| (Total costs of the company + Costs of financing) | |
Table 3: Cost of financing of Sparkly Ltd
(Source: MS Excel)
(iii) Determination of the level of risks in the NPV
The total costs of financing and sales price of the apartments of this project are £1522500 and £47,750. Hence, it can be viewed that there is a high risk in making an investment in this project as the total cost of the project is 31 times of yearly profit of this project.
(b) Evaluation of merits and demerits of internal rate of return
Merits
Internal rate of return (IRR) is used to evaluate the breakeven discount rate of a particular project. With the usage of the time value of money, it is concentrated in ascertaining the potentiality of a particular project. Investors prefer IRR more than NPV and the payback method just because it is easy to understand and can be used for further implementation. As opined by Speranda and Speranda (2019), determination of the cost of capital is easier in IRR as hurdle rates are not used in calculating the future returns of the investments. One of the merits of IRR is that it helps in ranking the projects based on profitability. The investor wants to select the most profitable investments as he can be able to increase the operational profitability of the organization.
Demerits
Sometimes the projected cost of capital may not be reflecting the complete financial scenario of the organization. Hurdle rates are not used in evaluating the cost of capital of the organization as it can be considered as an incomplete technique of financial projection. As stated by Jafari et al. (2020), IRR does not consider the scope and size of the organization as investment opportunities comparison may be inappropriate for the investors. In the projected cash flows of IRR techniques, the projected cash flows of a particular organization cannot be considered. Hence, the future costs are ignored in estimating investment potentiality for the business. Using IRR techniques in evaluating the value of an investment, it can be assumed that the rate of return of the future cash flows will be the same as the present cash flows.
Question 2
(a) Determination of the optimal allocation of the investment budget
| Optical allocation in the investment budget | |||
| Project | A (£000) | B (£000) | C (£000) |
| Initial investment ((£000) | £ 15.00 | £ 34.00 | £ 14.00 |
| Annual Sales Revenues | £ 28.00 | £ 35.00 | £ 20.00 |
| Annual Fixed Costs | £ 7.00 | £ 4.00 | £ 6.00 |
| Life of project | £ 5.00 | £ 4.00 | £ 7.00 |
| Costs of financing | £ 0.56 | £ 0.32 | £ 0.48 |
| Variable costs | £ 14.00 | £ 17.50 | £ 10.00 |
| Total costs | £ 21.56 | £ 21.82 | £ 16.48 |
| Profit gained by selling each projects | £ 6.44 | £ 13.18 | £ 3.52 |
| Total time is taken for repaying the initial investment in years | 2.329192547 | 2.579666161 | 3.977272727 |
Table 4: Determination of the optimal allocation of the investment budget
(Source: MS Excel)
(b) Distinction between soft and hard capital rationing
Capital rationing techniques can be used for the purpose of selecting the most feasible investment among a certain number of investments in the business. Capital rationing techniques can be used by financial institutions to select a particular project that will help in giving a higher rate of return in the future. As argued by Kim et al. (2021), there are two types of capital rationing such as hard and soft rationing techniques. Hard capital rationing techniques are used to control the financial polices and marketing strategies of the business. In contrast, capital expenditure-related projections can be evaluated with the help of soft capital rationing techniques.
Hard capital rationing techniques are used for those organizations which have a wide variety of operational activities in the business. In comparison, soft rationing is implemented in those firms which have limited managerial concerns in their operational activities. As stated by Kwan et al. (2018), hard rationing techniques are used in those firms which have no poor track record in their operational activities which means it considers operational performances evaluation in those organization which has been comparatively successful in the last two or three years. Moreover, one of the basic reasons for the soft rationing technique is to minimize the cost of funding a particular business. High-interest cover ratios are mainta9ned with the help of using soft capital rationing techniques in the business. In comparison, hard capital rationing techniques are used to increase the credit rating of an organization.
Question 3
(a) i. Evaluation of systematic risks and non-systematic risks of Vodafone Group
| Evaluation of systematic risks and non-systematic risks of Vodafone Group | ||
| Year | Vodafone Group plc | Market portfolio |
| 2003 | 43.9 | 4476.9 |
| 2004 | 46.6 | 4814.3 |
| 2005 | 43.9 | 5618.8 |
| 2006 | 47.2 | 6220.8 |
| 2007 | 67.4 | 6456.9 |
| 2008 | 54.6 | 4434.2 |
| 2009 | 63.3 | 5412.9 |
| 2010 | 81.1 | 5899.9 |
| 2011 | 93 | 5572.3 |
| 2012 | 156.6 | 5897.8 |
| 2013 | 148.7 | 6749.1 |
| 2014 | 154.9 | 6566.1 |
| 2015 | 147.9 | 6242.3 |
| 2016 | 184.4 | 7142.8 |
| 2017 | 129.8 | 7687.8 |
| 2018 | 129.8 | 6728.1 |
| 2019 | 132.3 | 7542.4 |
| 2020 | 112.8 | 6450.5 |
| Standard Deviation of the security (𝜎𝑚 2) | 47.10439664 | |
| 𝛽𝑖 2 | 6106.327778 | |
| Systematic risk (𝛽𝑖 2 × 𝜎𝑚 2) | 287634.8857 | |
| (𝜎𝑖 2) | 102.1222222 | |
| Non-systematic risk (𝜎𝑖 2 ) − (𝛽𝑖 2 × 𝜎𝑚 2 ) | 277205.9374 | |
Table 5: Evaluation of systematic risks and non-systematic risks of Vodafone Group
(Source: MS Excel)
ii. Estimation of BT group’s non-systematic risks and systematic risks
| Evaluation of systematic risks and non-systematic risks of Vodafone Group | ||
| Year | BT Group Plc | Market portfolio |
| 2003 | 87.9 | 4476.9 |
| 2004 | 99.2 | 4814.3 |
| 2005 | 114.2 | 5618.8 |
| 2006 | 162.7 | 6220.8 |
| 2007 | 152.1 | 6456.9 |
| 2008 | 81.7 | 4434.2 |
| 2009 | 85.5 | 5412.9 |
| 2010 | 120.2 | 5899.9 |
| 2011 | 132.5 | 5572.3 |
| 2012 | 166.8 | 5897.8 |
| 2013 | 282.8 | 6749.1 |
| 2014 | 308.2 | 6566.1 |
| 2015 | 368.8 | 6242.3 |
| 2016 | 296.6 | 7142.8 |
| 2017 | 230.3 | 7687.8 |
| 2018 | 214.9 | 6728.1 |
| 2019 | 188 | 7542.4 |
| 2020 | 132.3 | 6450.5 |
| Standard Deviation of the security (𝜎𝑚 2) | 86.54700355 | |
| 𝛽𝑖 2 | 6106.327778 | |
| Systematic risk (𝛽𝑖 2 × 𝜎𝑚 2) | 528484.3719 | |
| (𝜎𝑖 2) | 179.15 | |
| Non-systematic risk (𝜎𝑖 2 ) − (𝛽𝑖 2 × 𝜎𝑚 2 ) | 496389.6494 | |
Table 6: Estimation of BT group’s non-systematic risks and systematic risks
(Source: MS Excel)
(b) Estimation of market’s return
The standard deviation of the Vodafone and BT group plc is derived as 47.104 and 86.547 respectively for the last 18 years. As stated by Oladejo (2019), investors want to select those investments which have a higher market return in comparison with the other companies in the market. The systematic risks of BT and Vodafone group plc are 528484.3719 and 287634.8857 as it denotes that Vodafone group plc has lower risks in the market. However, the non-systematic risks of the Vodafone Group plc and BT plc are 277205.9374 and 496389.6494 individually. Hence, it can be viewed that systematic and non-systematic risks of Vodafone group plc are lower than BT Group plc. Hence, it is clear that Vodafone group plc has higher profitability and market return in the upcoming years.
(C) Evaluation of expected equilibrium risk premium for two shares
| Evaluation of expected equilibrium risk premium for two shares | ||
| Particulars | Vodafone Group plc | BT Group plc |
| Risk-free interest rates | 0.85% | 0.85% |
| Government bond rate | 3.20% | 4.70% |
| Inflation rate | 1.70% | 1.92% |
| Market return | 2.10% | 1.80% |
| Beta | 2.40% | 1.75% |
| Risk-free return on investment | 1.977228682 | 1.963228271 |
| Standard Deviation of the security (𝜎𝑚 2) | 47.104 | 86.547 |
| Determination of the risk premium | 45.12677132 | 84.58377173 |
Table 7: Evaluation of expected equilibrium risk premium for two shares
(Source: MS Excel)
Risk-free investments are considered as those investments in which the total risk of return is minimal than the other firms in the organization. As believed by Flogal et al. (2018), equilibrium in the market situation can help in mitigating the total risks involved in a certain project. However, risk premiums of Vodafone and BT group plc are 45.126 and 84.583 respectively as the market return of Vodafone group plc is higher than BT Group plc.
Reference list
Atmaz, A., 2020. Stock return extrapolation, option prices, and variance risk premium. Option Prices, and Variance Risk Premium (October 1, 2020).
Flögel, F., 2018. Distance and modern banks’ lending to SMEs: ethnographic insights from a comparison of regional and large banks in Germany. Journal of Economic Geography, 18(1), pp.35-57.
Jafari, H., Faraji, M. and Khaleghi Ardehali, P., 2020. A heuristic method to calculate the real internal rate of return (RIRR). International Journal of Applied Operational Research-An Open Access Journal, 10(1), pp.31-40.
Jakšič, M. and Marinč, M., 2019. Relationship banking and information technology: The role of artificial intelligence and FinTech. Risk Management, 21(1), pp.1-18.
Kim, K., Kim, J. and Yook, D., 2021. Analysis0020of Features Affecting Contracted Rate of Return of Korean PPP Projects. Sustainability, 13(6), p.3311.
Kopecky, J. and Taylor, A.M., 2020. The Murder-Suicide of the Rentier: Population Aging and the Risk Premium (No. w26943). National Bureau of Economic Research.
Kwan, T.H., Hu, Y. and Lin, C.S.K., 2018. Techno-economic analysis of a food waste valorisation process for lactic acid, lactide and poly (lactic acid) production. Journal of cleaner production, 181, pp.72-87.
Liberti, J.M. and Petersen, M.A., 2019. Information: Hard and soft. Review of Corporate Finance Studies, 8(1), pp.1-41.
Mukupa, G.M. and Offen, E.R., 2020. The Semimartingale Equilibrium Risk Premium for a Risk Seeking Investor. Journal of Mathematics Research, 12(4), pp.1-13.
Oladejo, N.K., 2019. Application of optimization principle in Landmark University project selection under multi-period capital rationing using linear and integer programming. Open Journal of Optimization, 8(3), pp.73-82.
Speranda, I. and Speranda, Z., 2019. The Comprehensive Method of Solving the Multiple Internal Rate of Return Problem. Montenegrin Journal of Economics, 15(1), pp.73-86.
Tursoy, T. and Berk, N., 2020. Stock Return and Risk Premium: Evidence from Turkey. Journal of Advanced Studies in Finance, 11(1), pp.5-8.
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