Week 9 - Financing a Business & Investment Appraisal

Question 1

What are Sources of INTERNAL FINANCE - LT and ST

Answer 1

• ST - Reducing Inventories level, delaying payments to suppliers
• LT - Retained Profit

Question 2

What are Sources of EXTERNAL FINANCE - LT, MT and ST

Answer 2

LT - Shares, Debentures, Long Terms, Bank Loans, Grants
MT - Leasing, Hire Purchase, Loans
ST - Bank Overdraft, Debt Factorin

Question 3

What are 3 Key Types of Debt Financing

Answer 3

1) Preferences Shares
2) Loans
3) Debentures

Question 4

Explain the Type of Debt Financing - PREFERENCES SHARES

Answer 4

• Usually Treated as a NCL in the SoFP
• Contain the Right to Recieve a Dividend before an Ordinary Shareholder i.e. thy take preference
• the Dividend will be of a fixed % each year, providing the company choosers to offer the dividend

Question 5

Explain the Type of Debt Financing - DEBENTURES

Answer 5

• offered by a Company to Potential Investor
• Form of Security that a Company Grants to a Lender in Exchange for Funding
• offers a Consistent Rate of Return, therefore Less Risky than Purchasing Shares

Question 6

What are the 2 Types of Cost of Capital

Answer 6

• Cost of Equity
• Cost of Debt

Question 7

What is the COST Of EQUITY?

Answer 7

• the Rate of Return Expected from Shareholders –> this is More Difficult to Assess, but is Based Upon their Expectations for Dividends and Increase in Investement

Question 8

What is the COST of DEBT?

Answer 8

Cost the Company Incurrs Through the Debt Financing –> usually Be the Rate of Interest Being Changed on the Debt

Question 9

Why is it Important to Know the Cost of Capital?

Answer 9

• Plays Key Role in Decision Making of Financial Management
• Helps Design the Capital Structure Considering the Cost of Each Source of Financing
• Represents the Minimum Return a Company Needs to Achieve in Order to Justify the Cost of a Capital Project

Question 10

What is the Weighted Average Cost of Capital (WAAC)

Answer 10

• Method to Work Out their Cost of Capital if they’re Financed Through a Mix of Debt & Equity

Question 11

What is the Weight Average Cost of Capital (WACC) Formula

Answer 11

(E/V X Re) + (D/V x Rd x (1-Tc))

Question 12

What is the Meanings of the LETTERS in the WAAC Formula

Answer 12

E = Market Value of Firm’s Equity
D = Market Value of the Firm’s Debt
V = E + D
Re = Cost of Equity
Rd = Cost of Deby
Tc = Corporate Tax Rate

Question 13

What is INVESTMENT APPRAISAL

Answer 13

• a Process of Analysing Whether an Investment Project is Worthwhile or Not
• Justifies the Investment in a Project Providing the Rationale for Spending Limited Resources

Question 14

What are the 4 INVESTMENT APPRAISAL METHODS?

Answer 14

• Accounting Rate Return (ARR)
• Payback Period (PP)
• Internal Rate of Return (IRR)
• Net Present Value (NPV)

Question 15

Explain the IA Method - ACCOUNTING RATE RETURN

Answer 15

• expresses the Average Accounting Operating Profit that the Investment will Generate as a Percentage of the Capital Investment

Question 16

Explain the IA Method - PAYBACK PERIOD

Answer 16

• Expresses the Time for the Initial Investment to be Repaid

Question 17

Explain the IA Method - INTERNAL RATE of RETURN

Answer 17

Represents the Yield from a Parrtiuclar Investment but the term Internal Reacts to the Fact the Calculation Excludes external factors, e.g. inflation

Question 18

Explain the IA Method - NET PRESENT VALUE (NPV)

Answer 18

works out the NPV of the Cash Inflows and Outflows of a Capital Investment Project
- helps Managers Make Sensible Investment Decisions and to Analyse the Probability of a Project of Investment

Question 19

Explain the NPV Concept - The Time Value of Money

Answer 19

• Concept that the Current Value of Money is Higher than its Future Value, Given it’s Potential to Earn in Years to Come
• Present Value of Money : Money that could be Invested when in hand for a better returns in future
• Future Value of Money : the Same Amount of Money is Subject to Uncertainties and Loses of Money in Future

Question 20

What is the DISCOUNT FACTOR Formula for NPV?

Answer 20

Dn = 1 / (1+r) ^n

• r = discount rate
• n = number of years ahead