This report has three sections separated by a, b and c. Section (a) describes the analysis of investment appraisal its interpretation, but the main analysis is put under appendex1. Next section b has words for discussion of debt and equity financing through advantages and disadvantages with example considering cost of capital of 10% at beginning. At the last section different valuation methods are discussed with its advantages and disadvantages.
Few assumptions are considered for analysis:
1. An imaginary position and Income statement
2. Cost of capital is 10% is calculated from the assumptions below
|Risk Free Rate |3.8% |
|Market Return |11% |
|Matero's beta |1.38 |
|Matero's expected cost of equity |14% |
|Matero's cost of debt |6% |
| | |
3. Stock price is 20GBP
a. INVESTMENT APPRAISAL
In the above graph the simulated value of NPV at different expected cost of capital is calculated and IRR of the project is 14% that is higher that present cost of capital. Details of the analysis is in appendix 1
Metero’s initial investment amount 210000GBP is for purchasing the crushing machine which is large amount at initial investment. But using the discounted cash flows valuation method with the 10% discounting rate (cost of capital is 10%) it can be found that the investment has nearly 14% return. The investment has some residual money but regular cash flows for the next 5 years can earn a reasonable profit to Matero. So it can be recommended that Metero should invest in that project.
As shown in analysis, even the cost of capital increases up to 14% then this project is not loss making.
Advantages of the NPV method is that the present value amount at any discount rate can be quantified, at the same time the IRR can help to identify the maximum cost of capital can be raised to get the zero sum result but avoiding the loss. Hence IRR can help to manage risk.
Financing can be made in two ways like equity and debt financing. Brief idea in the form of advantages and disadvantages are noted below.
For the requirement of huge capital at initial investment profit sharing through selling equities can earn huge amount from small investors, HNI, angel investor or venture capitalist.
Advantages to equity financing:
• Compared to loan it is less risky as one does not have to repay and as alternative it is very good for those who cannot take debt.
• One can enhance credibility to his firm by tapping into network of the investor.
• Investors seek long term investment without expecting immediate yield on their investment.
• Profits are not used to loan repayment.
• For business expansion advantage of cash on hand exists.
• If the business shuts down the need for paying back the investment is not here.
Disadvantages to equity financing:
• The requirement of returns may be more than the rate one has to pay for a bank loan
• The ownership of the company and profits will be shared with the investors.
• Consultation with investment is required before taking important decisions and there may be disagreement with investors.
• One may require cashing in his portion of the business when the disagreements with investors are irreconcilable and without him the investors can continue the firm.
• Acquiring right investors is time taking and requires perseverance.
A bank gives loan and investors also give loan but two are different from business point of view. Loan from investors is equivalent to sharing equity but debt for other