# Strategic And Financial Decision-making: Capital Budgeting Techniques (Research Paper Sample)

The use of capital budgeting techniques to determine the viable projects for TESCO LIMITED COMPANY. THE IMPORTANCE OF BETA TO A COMPANY. THE ADVANTAGES AND DISADVANTAGES OF ORGANIC AND ACQUISITION GROWTH. THE THEORIES THAT GUIDE THE MANAGEMENT OF COMPANIES WHILE DECIDING THE BEST SOURCE OF FINANCING.

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STRATEGIC AND FINANCIAL DECISION MAKING

by [Name]

Course

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Location of Institution

Date

Strategic and Financial Decision Making

Task 1

Since the inflation has to be factored in the NPV, it is important to determine the nominal interest rate which is calculated using the formula indicated below.

Rn=Ri + Rr(1+Ri) (Berceanu and Bandoi 2018, p.322).

Ri=The inflation rate per year

Rn=Nominal rate of interest

Rr=Real interest rate.

Rn=0.05+0.105(1+0.05)

=16.025

Year

1

2

3

4

5

Cash Savings (£million)

4.50

7.00

14.00

12.40

8.75

Cash savings (£million) after inflation

4.77

7.42

14.84

13.14

9.28

Cash Operational Outflows (£ million)

1.50

3.00

6.00

5.40

3.75

Cash operational Outflows (£ million) after inflation

1.56

3.12

6.24

5.62

3.90

Net cash flow

3.21

4.30

8.60

7.53

5.38

Less taxation 28%

(0.90)

(1.20)

(2.41)

(2.11)

(1.51)

Net cash flow after tax

2.31

3.10

6.19

5.42

3.87

The table below shows the calculation of the net cash flow that will be utilized in calculating the NPV and IRR.

NPV=Cash flow/(1+Rn)^1+Cashflow/(1+Rn)^2+Cashhflow/(1+Rn)^n-Initial investment

NPV=2.31/(1+0.16025)+3.10/(1+0.16025)^2+6.19/(1+0.16025)^3+5.42/(1+0.16025)^4+3.87/(+0.16025)^5

=2.31*0.86+3.10*0.74+6.19*0.64+5.42*0.55+3.87*0.48

=1.99+2.30+3.96+2.99+1.84-14.5

=$13.09-14.5

= ($1.41)

The project has an NPV value of -$1.41 and, therefore, the investment if not financially worthwhile. One of the reasons why the project has a negative NPV is because of the inflation. If the inflation had not been put into consideration, the project's net present value would have been positive. Another reason why the NPV has a negative value is because of taxation. The tax effects minimize the net cash flow used to calculate the present value of inflows.

The internal rate of return would be the rate at which the present value of net cash flows would be equal to the investments.

IRR=PV cash inflows-Initial investment

Therefore, since the discount rate leads to negative value, for the NPV to be zero, the IRR should be lower than 16.025. Therefore, if the take a guess of 12.225%, the NPV calculation would be as indicated below.

NPV=2.31/(1+0.12225)+3.10/(1+0.12225)^2+6.19/(1+0.12225)^3+5.42/(1+0.12225)^4+3.87/(+0.12225)^5

=2.31*0.89+3.10*0.79+6.19*0.71+5.42*0.63+3.87*0.56

=2.06+2.46+4.38+3.42+2.17-14.5

=$13.09-14.5

= ($0.01)

Since the value is close to zero, the IRR is 12.225%

The project is not financially viable since the IRR of the investment is lower than the discount rate. Therefore, Tesco company should abandon the project to avoid making a loss in future.

b)

It is possible for the project to have a higher IRR and a lower NPV. If the project has a lower NPV compared to the first one, it implies that the investment is also not viable since the first one yielded to a negative value. If the project has a higher IRR than the first one, it is a reflection that the second investment has a higher negative value. Therefore, neither of the projects should be selected by the management of the firm since they all lead to a loss. Both managers at the head office and the one at the branch should carry out further research to identify similar projects that have a positive NPV since the projects that have been selected are not viable. The rule applied on net present value is that a project should be accepted if it has a positive NPV value.

Task 2

Beta is one of the tools that is utilized by the stakeholders of firms to analyze an investment (Gardner and Mcgowan 2010, p.103). If the beta value of Tesco is 0.49 while that of the international hotel group plc is 1.18, it implies that the return on the former's shares is less volatile. There exists a disparity between the beta values of different companies and it is mainly caused by the variance in returns. Beta is calculated by estimating the coefficient of a slope from historical stock returns (Pamane and Vikpossi 2014, p.13). Therefore, the beta estimates for Tesco and International hotel are different since their past security returns are not similar.

Additionally, the beta can be evaluated by estimating the slope coefficient of the difference between the market return and the risk-free rate. The size of the firm is that the other factors that cause the beta estimate of two companies to differ. Large organization exhibit a lower degree of returns correlation compared to small entities. The reason why the size of the firm is relevant is that the big-ask spread is linked to it. The degree of adjustment due to the availability of new information would depend on the size of the organization (Pamane and Vikpossi 2014, p.15).

The beta values are used to symbolize the level of risk in the company's return on shares. The beta has various kind of impacts among the stakeholders of a firm. One of the impacts that the beta has is that it is used to estimate the cost of equity of a firm. The capital asset pricing model, a concept used to calculate the cost of equity, incorporates the beta value in the formula (Pamane and Vikpossi 2014, p.20). If the cost of equity is high, it implies that the entity will have a weighted average cost of capital that is high making most of the internal project not financially worthwhile. The management use the cost of equity to evaluate whether investment projects are viable. Once the cost of equity has been calculated, the financial manager uses the v...

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