Foundation Degree in Business and Management (Year 2)

Business Finance (BMS512)

 

School of Business, Management and Professional

Semester: 1 (Tutor: S. A. Palan)

TITLE: Business Report

Completion of this work will satisfy the following learning outcomes from module BMS512:

LO1 Analyse a range of financial strategies including budgets, financial management and accounting

LO2 Evaluate approaches to procurement and contracting within an organisation

LO3 Assess the commercial context that an organisation operates within

 

CASE STUDY

S plc is to add a new line of computer games to its highly successful product range. You are required to provide an evaluation of the new investment with a five-year expected life. The following budgeted projections relate to the new investment proposal for this new line.

Initial cash investment:                               (£000)

               Production equipment                  1,000 

               Staff training provision                   100

               Advertising & promotion costs         20

               Incremental working capital           180

 

 

Cost of sales: 30% of sales revenues

Incremental operation costs £100,000 per annum

Depreciation of production equipment: 20% on a straight line with no salvage value.

S plc is a listed company. Its cost of capital is set at 20%.     

 

TASK

A):Write a report to address the following

1) Why is the capital investment appraisal process so important to S plc?

 

2) Prepare a cash flow analysis statement for the above new investment.

 

3) What is the payback period for the new investment? If S plc imposes a three-year maximum payback should the project be accepted?

 

4) Determine the net present value for the new investment? Should the investment proposal be accepted? Explain why?

5) Describe the logic behind the net present value approach. What is the relationship between net present

    value and cost of capital.

 

7) Calculate the internal rate of return for the investment proposal. Should the proposal be accepted?

    Would a change in the cost of capital affect the internal rate of return?

 

8) Discuss why the net present value method is often regarded to be superior to the internal rate of return.

[LO1]           

B):S plc finds that the cheapest source of long-term finance available to it is through a bank loan.

Critically contrast this with an equity issue for all its long-term finance requirements.

[LO3] 

C): An existing computer game is to be introduced into a new market segment by S plc. 

   The following details relating to this product:

    Selling price per game: £100.

    Variable costs per game: £60.

    Fixed costs per annum specific to this game: £300,000.

 

Required: 

 

1) Calculate the breakeven sales revenue, the sales revenue to achieve a target profit of £120,000 

    and the margin of safety.

 

2) What are the consequences of a price increase or decrease of 10%.

 

3) Cost-volume-profit analysis provides important information for management decisions. The analysis illustrates relationships that prevail under a particular set of assumptions. Critically comment on these assumptions.                                                                                                                                  

[LO3]

D):

 

1) Distinguish between three categories of suppliers: strategic suppliers, preferred suppliers and

    transactional suppliers.

 

2) Compare the advantages of single sourcing and multiple sourcing in the context of procurement. 

                                                                                                                                                              

3) Explain what cross-sourcing is using an example and how it benefits the buyer.

[LO2]

Other relevant assessment information:

You will need to include and reference at least 8 different sources including 4 academic textbooks and 2 academic journals to help provide supporting evidence for any assertions that you make within your report.

Your report should outline your research, judgements as well as conclusions drawn. 3,000 words (+ or - 10%). All written work should be submitted online, through Turnitin. You must include both a reference list and a bibliography.

The completion of your work will satisfy 75% of the assessment for this module

Issue Date: 15.07.2021

Submission Date:  29.10.2021

Feedback Date: 26.11.2021

 

SKILLS DEVELOPMENT

The skills development opportunities identified in this report are:

Written communication, teamwork and research skills in the completion of assessments and during the formative assessment and interaction within the classroom.

Application of theory to organisational practice

 

MARKING CRITERIA

 

Undergraduate Generic Marking Criteria Foundation Degree Level 5

 

 

Introduction

The report highlights key aspects of business finance like Investment appraisal techniques, evaluation of financing options, break-even analysis, different categories of suppliers, etc. The study covers all these topics in different tasks based on practical case study scenarios. The aim of the study is to enhance the practical understanding of business finance and related aspects. 

 

Main Body

Task A

1) Importance of capital investment appraisal process to S plc:

Capital investment appraisal not just demonstrates an investment project's corresponding financial viability, but could also evaluate how effectively the investment proposal fits into an enterprise's organizational strategies. Finally, how efficiently an investment proposal advances strategic targets will have broader financial impacts. The overall feasibility of the investment project could be revealed by capital investment appraisal. This includes forecasted net cash flows as well as periodic earnings. Usually, it will contain an NPV analysis. These could offer S plc a decent indication of the investment proposal's likely profitability with respect to both the shorter and longer run. When creating an investment strategy like S plc and capital projects, capital investment appraisal should be used to ensure value for funds. It does not represent profits or losses for the corporation overall, but instead costs comparison with reference to those aspects of the project where there are opportunities for changes (Dyson, and Berry, 2014). 

Capital investments decisions are critical criteria that a business entity like S plc must employ in an attempt to implement its organizational strategy. Thus, it must encompass strategic choices, advertising decisions, and the consequences of human resources as part of an entire company assessment. Growth, reducing costs, market growth, purchases, and disposals leasing or acquire are instances of such decisions. As its aim, it is conceivable to analyze the validity of the prospects for investment appraisal through contrasting the anticipated advantages with the projected expenditures (Azeez, 2014).

2) Cashflow analysis statement:

(£000)

3) Payback period of new investment and If S plc imposes a three-year maximum payback should the project be accepted: 

 

Payback Period = 2 year + (380/740) = 2.51 years or 2 years and 6.16 months

As per the above calculation, investment has a payback period of 2 years and 6.16 months. In case of S Plc imposes a 3 years maximum standard for payback period then investment project would be viable for business since the actual payback period is less than 3 years.

4) Computation of NPV for the new investment and decision of whether investment proposal should be accepted:

As per the above computation, the investment’s NPV is 285.79 which is a positive figure which shows that at the end of its life cycle the investment proposal would provide more than the initial investment made. Thus, the investment proposal would be viable for the business and should be accepted.

5) Logic behind NPV approach and relationship between net present value and cost of capital.

Net-present value of investment selection provides decision-makers with a tool for evaluating multiple distinct choices when investment term covers some timeframe. The rationale behind the NPV is that its investments (loan) are made with the assumption that future benefits will be achieved, although that the upcoming benefits should be paid/settled for with such a loan. In essence, the aim is for project investments to become self-sustaining; such that, such loans should create enough advantages to cover loan's repayment (Fokkema, Buijs, and Vis, 2017). If more funds are required to meet the payback, the project/investment proposal is deemed bad. In the same way, that borrower takes loan to create some type of reward (in the instance of a corporation, benefit is generally a source of income), the lender views loan to be an investment. The lender levies a lending rate in return for rendering funds accessible to borrower; such interest rate represents the lender's cash flow. 

Banks charge borrowers interest rates and pay lending rates to deposits (from whom banks are particularly "borrowing" funds). Likewise, corporate bonds pay interest (coupons). While contemplating this sort of investment, Business decisions makers generally evaluate the interest level that would be earned on their cash. That return rate offers a benchmark against which investments may be compared over period. NPV assessments take a specific pound amount from a later period as well as discount it to value of the current year. Individuals should employ interest rates with respect to the calculation in an attempt to perform this appropriately. The costs-of-capital of a corporation, that is specified rate paid with respect to borrowed money, either debt funding or equity funding, is a common interest. As a result, there's a direct relationship between costs of capital and amount of net present value. Organizations like S plc can utilize a range of cost-of-capital percent rates to properly evaluate a proposed investment project utilizing the NPV method (Li, and Trutnevyte, 2017). 

Employing the cost-of-capital as well as NPV model has weaknesses that might result to bad consequences. Poor projections of prospective cash-flows, for instance, might lead to a project earning less financing. An improper costs-of-capital calculation could also contribute to bad outcomes; that's a particularly significant concern because cost-of-capital and NPV formulas require precision in an attempt to provide appropriate findings.

7) Computation of IRR and recommendation. Would a change in the cost of capital affect the internal rate of return?

NPV at cost of capital of 20% is 285.79

NPV at cost of capital of 10% :

Thus, IRR would be as follows:

IRR = 10% +[738.18/(738.18-285.79)]* (20-10)%

IRR = around 26.32% 

The change in cost-of-capital has no effect on IRR,  Usually, a shift in cost-of-capital has little effect on IRR. The periodic interest rate, or discounting rate, necessary for NPV of all cash-flows to equals zero is expressed as IRR. 

When rendering investment-related decisions, it is critical to contrast IRR to applied cost of capital: when the IRR is greater than cost-of-capital, the investment proposal should be beneficial, with a favorable NPV as well as if IRR is lesser than applied costs of capital, the proposal or investment must be avoided. To assess steady investments throughout period, NPV is recommended above the IRR. Therefore, while a larger cost-of-capital would not affect IRR, this would result in lesser suitable investment decisions while employing IRR as a way of analyzing such investments decisions (Wnuk-Pel, 2014).

8) Discuss why the net present value method is often regarded to be superior to internal rate of return.

NPV is preferable to IRR since IRR disregards the economic size of a given project/investment proposal. Another disadvantage of IRR is that it assumes both discounting and reinvestments at same time. When there is a disagreement between NPV as well as IRR, definitely choose the investment with the greater NPV. This is owing to the fact that IRR implicitly implies that project's cash flows may be reinvested at IRR. This hypothesis is troublesome since there's no assurance that similarly profitable possibilities would be accessible at the same time as cash-flows commence. 

Reinvestment risks refer to the danger of obtaining financial flows but not having adequate possibilities for reinvestment. Moreover, NPV, on another side, is free of this problematic premise since it implies reinvestment at costs-of-capital, which is both conservative as well as reasonable (Okolelova, Shibaeva, and Trukhina, 2018).

Task B

A bank loan is obtaining funds from a bank, as borrowing is also regarded as debt funding. Debt funding is borrowing funds without giving up ownership rights. Bank loans demand the payment of both interests and principal amount on a specific date; nevertheless, there are rigorous terms and contracts in place because if debt requirements are not fulfilled or are violated, there are serious penalties to confront. Typically, the interest level and maturity date or repayment date of loan borrowings are fixed or pre-defined. The principal might be repaid in total or in instalments as determined upon in bank loan arrangement (Bergbrant, Bradley, and Hunter, 2017). 

According to the terms of a contract, the provider of the fund, i.e. the bank, is entitled to money back. As a result, lending funds to the corporation is generally risk-free, because the firm will undoubtedly get principal as well as the agreed-upon interest over the same. Bank Loans could be secured loans as well as unsecured loan. Financial security is often a pledge or assurance that the bank loan would be repaid; such security could be of any form. Certain lenders, on other hand, may offer business money based on investment proposals or the reputation associated with company or brand. Multiple types of securities could be given in order to get borrowed funds relying on security, and debt finance could be obtained as a distinct form of unsecured lending (Morellec, Nikolov, and Zucchi, 2014).

In contrast, equity funding is less riskier than bank loans. Except as otherwise specified in the contract, debtors will not have the power to affect management. In contrast, company's equity holders would undoubtedly have influence over management. Whether it is specified in the contract, debts could be turned into equity, but equity cannot be transformed into debts. The length for which bank loan is accepted remains fixed, but the timeframe for which equity financing has been chosen remains unknown. Bank loans have a termination date, as well as a preset interest rate, must be paid on them. On contrary, equity financing has no maturity period, thus dividend payouts are needed to be paid on it only when the corporation earns profits (Sarkar, and Zhang, 2020).

Task C

1) Calculate the breakeven sales revenue, the sales revenue to achieve a target profit of £120,000 and the margin of safety

 

 

 

 

2) What are the consequences of a price increase or decrease of 10%:

Consequences of a price increase of 10%:

 

 

Consequence of price decrease of 10%:

 

 

 

3) Cost-volume-profit analysis provides important information for management decisions. The analysis illustrates relationships that prevail under a particular set of assumptions:

Costs-volume-profit analysis pertains to the systematic evaluation of interrelationship among selling prices, revenues and output quantity, costs, expenditures, and earnings. The costs-volume-profit analysis has frequently used a method that provides managers with helpful information with respect to decision making. Whenever a company is confronted with managerial challenges that have costs volume and profit effects, the costs-volume-profit evaluation would be used to make smart and reasonable decisions. A costs-volume-profit study is a quantifiable representation of a business product's economics (Shen, Wang, Cao, and Li, 2020). 

The CVP analysis, which expresses the connection between business product's revenue as well as costs function, is employed to analyze the financial ramifications of a broad range of tactical and administrative decisions. CVP analysis is an evaluation of the interrelationships between elements such as product prices, quantity or activity levels, each-unit variable cost, overall fixed cost, and product mix. Furthermore, the CVP analysis is a significant component in many choices, covering product line selection, pricing, marketing tactics, and use of productive capabilities (Stoenoiu, 2018).

Underpinning the procedure of CVP analysis is a key principle stating that at lowest level-of-activity, costs exceeds income, though as activity rises, revenue goes up faster than costs, and ultimately the two amounts are equivalent, after which revenue exceeds costs until lessening returns carry cost greater than income once again.  Such a concept describes CVP analysis in a curved way. Costs and revenue curves, while theoretically valid, are not practicable. In business, there is necessity to include additional information pertaining to costs behavior as well as selling policy in order to assure that a viable model could be developed based on these principles (Ihemeje, Okereafor, and Ogungbangb, 2015). In this regard, following are major fundamental assumptions relating to CVP analysis, as follows:

The behaviour, as well as revenues, are both linear.

The sales price is predetermined and constant.

All costs may be broken down into fixed versus variable components

The overall fixed costs are constant

Variable costs are proportionate to quantity.

The sole costs driver is volume.

The prices of manufacturing inputs (for example, materials) are stable.

Task D

Distinguish between three categories of suppliers: strategic suppliers, preferred suppliers, and transactional suppliers:

Strategic Suppliers: Strategic suppliers pertain to those that account for a substantial portion of revenue (60 per cent to 80 per cent), show devotion to partners (exclusivity, restricted distribution), are convenient to do trade with, and bring both expansion and profitability. It usually represents 6-10 vendors. Strategic suppliers generally are not the same as traditional vendors. These cannot be handled on a massive scale in e-auction platforms, nor could they be subjected to universal price reduction requests. They are strong bilateral partnerships that need patience and trustworthiness. As a result, the necessary purchaser investment in partnerships should be repaid with a broad set of supplier advantages. These could be represented as product innovation, risks reduction programs, and supplies system re-engineering as outcomes of effective strategic supplier collaborations (Lulaj, and Iseni, 2018). 

Preferred Suppliers: These pertain to is a firm which has an arrangement with another corporation to offer both products/services to that organization. These kinds of collaborations are widespread in the tourism business, where there's the possibility of symbiotic as well as mutually advantageous relationships. For illustration, an agency could supply a large number of customers to hotel chain in consideration of more attractive pricing, giving the agency an edge (Kim, 2015).

Transactional suppliers: These suppliers do not pose a danger to the firm since they provide common, standardized parts. Transactional providers sell items with little to no specificity. Transactional suppliers impose no responsibility on the lender to conserve a specific amount; such that, mortgages are not connected to borrowers' spending behavior. When opposed to certain other supplier categories, transactional providers are less close to borrower's domicile. To conclude, one of key concepts that distinguish transactional suppliers is timely credit: Credit must be made accessible where it's most required, with the quickest transaction procedure and time feasible (Clauss, and Spieth, 2016).

Compare the advantages of single sourcing and multiple sourcing in the context of procurement.

Single-Sourcing: This approach commits to buying a certain resource from only one provider. Businesses might profit from this when the provider is well-matched as well as dependable (O'Connor, Yang, and Jiang, 2018). As an instance:

Building a connection with a single supplier is simpler than with numerous suppliers.

A partnership strategy may assist establish credibility and mutual advantages.

If businesses order from a single source, then business costs could be lower owing to economies of scale.

Systems connectivity could be simpler with single provider.

Businesses that want to distribute demand among a variety of suppliers which have greater capability and are much more reactive to buyer may profit from multiple sourcing approaches. This is also required when a single supplier is insufficient to satisfy the purchasing organization's overall needs, such as when product contains many components which no one source can supply. 

Reduced reliance upon any one source giving a safety netting if a provider runs into problems

Greater flexibility to deal with unforeseen occurrences that might jeopardize capacity

Smaller bottlenecks because many suppliers can fulfill peak demand

Suppliers are frequently motivated to enhance their costs and services as a result of competition.

Supplier competitiveness typically gives the customer additional negotiating power.

Explain what cross-sourcing is using an example and how it benefits the buyer.

Cross Sourcing pertains to a sourcing strategy in which a corporation uses a single supplier for one particular part or management and other suppliers with comparable capabilities for other components or administration, with idea that each provider can act as reinforcing for other suppliers. Cross sourcing act as store network standard procedure for using two suppliers for a certain element, materials, product, or management. Outside of its precise meaning, the phrase "double sourcing" commonly used to mean "multi-sourcing," that could include greater than two parties. Organizations use this method to reduce the risk of relying on a singular source, a practice known as sole sourcing. Surprisingly, sole sourcing indicates that only one provider is available (Vitasek, 2016).

The advantages of cross-border purchasing include simple accessibility of RM, low labor costs, accessibility to a skill pool, and so on. Furthermore, commercial enterprises might profit from procurement destination's strong infrastructure. It also assists companies in lowering the pricing of their products/services. There are several benefits to sourcing operations that cannot be denied. Global sourcing is feasible alternative for marketers looking to survive in this competitive marketplace competition. 

The concept underlying cross-sourcing approach is that one provider may serve as key backup for other in the case of a breakdown. In a firm, for instance, cross-supplying might occur when a manufacturer ordered the corporation to supply one type of product for their finished item but asked another organization to supply another product. In the case that supply from one of these is disrupted, either of these may supply both (Liu, Li, Shi, and Liu, 2017).

Conclusion

From the above study, this has been articulated that Business financing provides funds for firms, especially small enterprises, to start-up, expand, and hire new employees. All of these advantages associated with supplying money to businesses highlight the significance of business financing since local real economic growth frequently starts with small businesses and their decision-making.

References

Books and Journals:

Azeez, W., 2014. Capital Investment Appraisal in Retail Business Management: Sainsbury's as a Case Study. Available at SSRN 2392288.

Bergbrant, M.C., Bradley, D. and Hunter, D.M., 2017. Does bank loan supply affect the supply of equity capital? Evidence from new share issuance and withdrawal. Journal of Financial Intermediation, 29, pp.32-45.

Clauss, T. and Spieth, P., 2016. Treat your suppliers right! Aligning strategic innovation orientation in captive supplier relationships with relational and transactional governance mechanisms. R&D Management, 46(S3), pp.1044-1061.

Dyson, R.G. and Berry, R.H., 2014. Capital investment appraisal. Developments in Operational Research: Frontiers of Operational Research and Applied Systems Analysis, p.59.

Fokkema, J.E., Buijs, P. and Vis, I.F., 2017. An investment appraisal method to compare LNG-fueled and conventional vessels. Transportation Research Part D: Transport and Environment, 56, pp.229-240.

Ihemeje, J.C., Okereafor, G. and Ogungbangb, B.M., 2015. Cost-volume-profit analysis and decision making in the manufacturing industries of Nigeria. Journal of International Business Research and Marketing, 1(1), pp.7-15.

Kim, S.H., 2015. Cost-Volume-Profit Analysis for a Multi-Product Company: Micro Approach. International Journal of Accounting and Financial Reporting, 5(1), pp.23-35.

Li, F.G. and Trutnevyte, E., 2017. Investment appraisal of cost-optimal and near-optimal pathways for the UK electricity sector transition to 2050. Applied energy, 189, pp.89-109.

Liu, Y., Li, Y., Shi, L.H. and Liu, T., 2017. Knowledge transfer in buyer-supplier relationships: The role of transactional and relational governance mechanisms. Journal of Business Research, 78, pp.285-293.

Lulaj, E. and Iseni, E., 2018. Role of analysis CVP (Cost-Volume-Profit) as important indicator for planning and making decisions in the business environment. European Journal of Economics and Business Studies, 4(2), pp.99-114.

Morellec, E., Nikolov, B. and Zucchi, F., 2014. Competition, cash holdings, and financing decisions. Swiss Finance Institute Research Paper, (13-72).

O'Connor, N.G., Yang, Z. and Jiang, L., 2018. Challenges in gaining supply chain competitiveness: Supplier response strategies and determinants. Industrial Marketing Management, 72, pp.138-151.

Okolelova, E., Shibaeva, M. and Trukhina, N., 2018. Model of investment appraisal of high-rise construction with account of cost of land resources. In E3S Web of Conferences (Vol. 33, p. 03014). EDP Sciences.

Sarkar, S. and Zhang, C., 2020. Investment and financing decisions with learning-curve technology. Journal of Banking & Finance, 121, p.105967.

Shen, B., Wang, X., Cao, Y. and Li, Q., 2020. Financing decisions in supply chains with a capital‐constrained manufacturer: Competition and risk. International Transactions in Operational Research, 27(5), pp.2422-2448

Stoenoiu, C.E., 2018. Sensitivity of indicators used in cost-volume-profit analysis. In MATEC Web of Conferences (Vol. 184, p. 04003). EDP Sciences.

Vitasek, K., 2016. Strategic sourcing business models. Strategic Outsourcing: An International Journal.

Wagner, S.M. and Bode, C., 2014. Supplier relationship-specific investments and the role of safeguards for supplier innovation sharing. Journal of Operations Management, 32(3), pp.65-78.

 

Wnuk-Pel, T., 2014. The practice and factors determining the selection of capital budgeting methods–evidence from the field. Procedia-Social and Behavioral Sciences, 156, pp.612-616.