FINANCIAL MANAGEMENT

Financial Management



Financial Management

Question 1

(a. 1)

Year

(£)

Annual Cash Flow

Net Cashflow

1

100,000 25,000

2

125,000 40,000

3

165,000 45,000

4

210,000 45,000

29400

Net Present Value

239,400

(a.2)

Using Net Present Value procedure of buying into appraisal the task that has the largest 'real return' is chosen. In this case 'real return' entails snare money flows modified for the consequences of altering worth of cash over time. Inflation decreases the worth of cash that will be obtained some time in the future. The longer enterprises have to delay for flows of money to be developed from investments, the smaller the worth of the flow in genuine, or today's terms. If inflation is at 5%, then £100 obtained in a years time will be worth just over £95 in genuine periods, this is because inflation has decreased the genuine worth, or expending power of the money (Brealey, 2003, 84). We can glimpse that as more years overtake, the more inflation adds up, so the smaller and smaller the genuine value. In detail with inflation at 5%, genuine worth of cash is halved in 14 years, with inflation at 10% genuine worth of cash is halved with 7 years. So companies should permit for the consequences of inflation on the worth of future money flows. Using this procedure we adapt (discount) snare money flows for the probable consequences of inflation. We manage this because inflation decreases the genuine worth of money. £100 obtained in a year's time will have less buying power than £100 in your hand now, how much less will count upon the grade of inflation. Current inflation rates in the UK are round 3%, this is a reduced number in evaluation to inflation over the last 25 years. Above right are demonstrations of Discount Tables which adapt for inflation rates of 2.5% and 5%. These benches are utilised to adapt snare money flows into genuine values. If a firm anticipates a future inflation rate of 5%, and anticipates a buying into task to give a yearly come back of £10,000 over 5 years.

(b.1)

Fair Price of the Bond

Since the concern is payable semi-annually, we require to state everything in semi-annual terms.

Number of periods: The bonds have a 4-year maturity, so there will be 8 concern payments (at 6-month intervals).

Interest payments: The bonds will yield concern of £50 per year (i.e., 5% * £1,000), or £25 every six months.

Required rate: The needed rate of come back is the market rate of 6%. Therefore, the needed rate is 3% semi-annually.

 

Fair Value: Using 3% as the discount rate and 8 semi-annual periods:

Periods Cash flow x PVF = PVB

 (1-8) £ 25.00 x 7.0197 = 175.49

 ( 8 ) 1,000.00 x 0.7894 = 789.40 Fair Value = £964.89

 

Yield-to-maturity (or YTM):

The equitable worth (i.e., the present worth of the advantages, or PVB) is more than the cost (i.e., present worth of the charges, or PVC) of the bond, so we understand that the YTM is more than the semi-annual market rate of 3% (or 6% yearly ...