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    Financial Management Assignment Help

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    Financial Management Assignment Help


    Financial Management

    Introduction

    Financial management helps company to select profitable investment projects for the company (Madura, 2018), that will add value to the company and strengthen capital structure by choosing suitable funding source (Wikes,2018). The first section involve question number one, where behavior of dividend payment is discussed along with valuation system using dividend. We calculated share value of Planet using dividend and show the effect of changing capital structure also. In the second section we see the different tools for investment appraisal along with some calculation of a case in different method. Finally, we discuss the advantages and disadvantages of appraisal techniques in a nut shell.  

    Dividend Policy

    Calculating the fair price of Planet’s shares

    There are various methods and theories to evaluate the value of a company’s share. Dividend discounting model is one of those popular models. Dividend discount model evaluate the price of a share by future expected payment of dividend irrespective of current price or market condition (Brigham, 2017). We simply can assume the reason behind this theory, but there may be some drawback of this methods. If a company generate enough dividend, we simply assume that it has capabilities to generate handsome amount of profit which can be distributed among shareholders. So, that dividend is only factor is being considered in dividend discounting model. Net present value of dividend is the determiner of the price of share. We will see various type of dividend model below.

    Zero growth model: Many companies doesn’t increase or decrease dividend over the year rather a certain amount of dividend is given with a certain time interval which called zero growth model. This type of model is popular among those who need to generate regular current income.

    Constant growth model: Some companies increase the amount of dividend at a constant rate over the year. The model is being used such cases it called constant growth model (Pfeiffer, 2014). A formula is being used to calculate the value of stock where we need amount of dividend, cost of capital and rate of growth of the dividend to calculate the value. 

    Multiple growth model: Some company doesn’t follow zero growth or constant growth policy to pay dividend rather they give dividend according to earnings of that period. Stick to a certain dividend policy is difficult as earning is not predictable and fluctuate regularly and company is not following certain policy for that reasons. The model used for valuing such stock is known as multiple growth model (Clark, 2015). 

    We can calculate the current share price of the Planet’s share using various models, dividend discounting model is one of them that can be used. The following information is given in the question: 

    Given that,

    Current dividend 20p

    Last four years dividend 13p, 14p, 17p and 18p respectively. 

    So, the dividend growth rates are:

    To calculate the value of the stock using the dividend discount model the following formula will be used: 

     D1: Expected dividend of the next year which is D0 (1+g) where k indicates for cost of capital and g stands for growth rate.

    When we try to calculate value of a stock for a future period, we need to estimate dividend for the period. Dividend estimation can be done in various ways. Here we will use average of past four years dividend to get an estimated dividend amount for the next year (Madura, 2018). If the growth rate of dividend were constant, we can use that but in our case the growth rate was fluctuating so we will use average of previous periods. Using the estimated dividend for next year fair value of share price can be calculated which is as follows: 

    Here we get the expected shares price of the company will be 9.03. 

    Calculating new share price of Planet’s share 

    When company introduce bigger amount of debt in its capital structure the risk exposure of shareholders increases with the amount of debt.  So, when shareholder will increase the required rate of return it will impact on share price of the company (Clark, 2015). As we know that fair value of share is function of dividend, cost of capital (which in turn we say rate of return for shareholders) and growth rate. Here rate of return placed in denominator so when the size of denominator increases the value of share will decrease. Here is the calculation of share price when planet will increase debt in its capital structure.

    Here we find that value of planet’s share has decreased in comparison to previous calculation. We assume all other things were remaining constant which means only rate of return was increased but dividend and growth was constant. We find the denominator as a result of deduction of rate of return and growth rate. As the rate of return were increase the size of denominator become large and overall value of the company is decreased. So, the share price of a company will decrease when amount of debt increases.  

     Outlining the problems of using dividend growth model for valuing the shares

    We frequently use dividend growth model to determine the price of a share as its very easy to use and convenient. But there are many problems related to this model. Some problems are even in such a height that can distort from original value significantly. Return of investors mostly depends on the selecting right type of share. So, when investors chose a share without knowing the original value their return will decrease. We will see the main problems of dividend growth model below: 

    Dividend Management: Dividend management is not so rare in real world. Many companies manage their dividend policy in various ways. Even dividend management is not illegal in some extent. Companies use dividend equalization funds to backup their dividend policy. When they fall short on a period, they use the fund to recover it. Even a company can give dividend when its in a loss. So, when we will evaluate the company, we will still get higher value as the company made dividend from dividend equalization fund.

    Misleading value for growth companies: Companies investment pattern vary due to the growth potential of the company. Mature companies have less investment opportunities than growth companies. Many companies finance their investment from internal sources rather other sorts of financing which may hinder them from giving dividend in a regular manner. As dividend growth model focus its evaluation on dividend growth, those investing companies will not reflect their value in dividend growth model. Growth companies creating real value by investing various projects but unable to pay dividend regularly that doesn’t mean that it has low potential rather sometimes it has more potential than the companies which are giving dividend in growth manner (Pfeiffer, 2014) 

    Growth rate estimation: We need a growth rate to calculate the value of a share under growth model. There is a fundamental flaw in determining the growth rate. We get the growth rate by multiplying retention rate with return on equity. There is a strong debate on generating growth rate in such a way. Because there may happen many cases with retention amount. In worst-case scenario company may fail to invest in favorable projects. In the bad case scenario company is failed to generate current return of equity and in the best-case company is generating more than current rate of return. In all cases described above, the growth rate is not same with the rate we are using for estimating value. Getting precise growth rate is tough but it distorts the real value significantly which putting overvalue or undervalue of a share. So, should consider this factor when using growth model for stock evaluation.

    Negative value when Growth is Higher: Growth rate is an important component of Growth model. As we know growth is very positive sign for a company but when the growth is higher than cost of capital dividend growth model is fail to determine value of the stock (Kolb, 2016). When Growth rate is higher than the cost of capital the denominator become negative which generate a negative value for the intended stock. But in reality, when the growth rate of a company is high the value of that company is also high in turn per share value of that company must be high. 

    Not a reflector of the true intrinsic value:  Dividend growth model measure the share value based on dividend growth criteria but we already know that we can keep dividend growth alive with various way despite of loss. Net profits, cash flow, free cash flow and residual earning is the true output of a well performed and well operated company. When a company has positive value of all those segments the company has a high intrinsic value though it not makes any dividend payment. Dividend growth model can’t capture all those value in its model. So, in many cases dividend growth model can’t precisely determine the true value of a share. 


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