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

STRATEGIC AND FINANCIAL DECISION MAKING by [Name] Course Professor’s Name Institution 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 value to estimate the present value or the profitability index of a particular project. The beta value is also significant since it determines the extent to which the investors are willing to invest in a company. When the beta is high or when it is more than one, the stakeholders could consider the firm as risky. On the contrary a beta value of less than one attracts more investors to the business leading to additional capital required for investments. The beta value is also relevant in a business since it is used to evaluate the performance of the management of an enterprise. A manager who maintains a beta value that is less than one is regarded as more efficient compared to the one who has a beta value that is more than one. Beta is also used to determine the return of different portfolios and, hence, appraise the best option in the market (Pamani and Vikpossi 2014, p.18). The beta also impacts the trading at the stock market since the investors use it to evaluate the volatility of the company’s returns compared to the market. If a firm has a higher beta, it is likely that investors would not be willing to invest in the stock leading a decline in demand. When the demand of the shares falls, the prices are also negatively affected leading to a decline. Hence, the beta estimate is an important value to the various stakeholders of a particular company. Task 3 Organic growth refers to a strategic option that enables the organization’s resources to grow internally. A case in point the recruitment and training of new staff. In the case of Tesco, Organic growth would entail acquiring new staff in the hotel industry and nurturing them to compete in the new business environment. Organic growth is possible if the product is new or the technology utilized to produce goods is being applied for the first time (Sollner 2009, p.12). One of the benefits of an organic growth is that it entails a lower risk compared to acquisition. Tesco would not have to spend much finances while engaging in the hotel industry which implies that that threat of loss low. Another benefit of the organic growth is that it would rely on the existing strengths of the company (Sollner 2009, p.18). Therefore, Tesco would use it brand name to market the new products in the industry. There is a high likelihood that the consumers will start purchasing the new products since they are aware of the company’s performance in the past. Additionally, the other internal strength that the Tesco can utilize is the expertise of its employees. Some of the managers at Tesco can be appointed to lead the new business to enable it gain a comparative advantage. Therefore, Tesco would not incur additional financing to hire competent staff to run the new business. The other benefit of the organic acquisition is that the firm has a potential of growth in the long-run. Tesco will be venturing into a new industry which implies that the challenges faced will provide an opportunity for the firm to grow. The other advantage of the organic acquisition is that it can be financed using the retained earnings. The funds are utilized for research and development and assets required to start the business (Sollner 2009, p.16). Additionally, there is vast knowledge in the organic growth which makes it easier for an entity to grow. Due to the internal development processes that Tesco has undergone, there is a vast source of knowledge which is required for the hotel industry growth. Consequently, the sharing of knowledge between the existing and new enterprises will lead to innovation which is critical towards creating a competitive advantage. Tesco would also benefit from the organic growth because of the existing organization structure. Tesco has dominated the global market for a long duration which reflects that its organization’s structure has been effective (Sollner 2009, p.60). An acquisition refers to the process by which a firm acquires an established business (Sollner 2009, p.33). Rather than starting a new firm in the hotel industry, the business could but an entity that is in operation. One of the benefits of the acquisition is that is takes less time to attain the required capacity. A take over entails acquiring another company’s assets and cash flow which enables the business to grow within a short duration. When the business acquires the fixe...