Strategic and Financial Decision-making (acfi5022) Submitted to: Josphat Njuguna Omanga

The payback method
The idea of the payback method is to define the sum of years that is used for recovering the primary stock. Therefore, the payback is calculated by following formula:
Payback in the number of years = Initial Investment/Cash flow per year
Advantages of the payback method
The payback method is the easiest method to understand and easiest to evaluate the projects, this is factor belongs to cash flows. This is also the first indicator, finally, this considers the risk with the cash flows.
In contract the payback method has some drawbacks as well.
Ignores the time value of money:
The highly significant drawback of the payback method is that it does not take into account the period cost to the capital. Hard Cash has taken through the initial times of a plan to find a better power than money currents collected in subsequent lifetimes. Dual ventures might come up with the similar payback time, although some design produces extra money in the early on, while, the new development requires superior money in the following years. In this example, this method does not give a clear-cut resolve as to which plan has to be chosen.
Neglects cash flows received after payback period:
For a few schemes, the biggest money springs might not arise till later the return time has finished. These ventures might be affected by greater refunds on venture capital and might be desirable to schemes that come up with smaller return periods.
Ignores a project's profitability, for a plan says a little repayment time does not indicate that it is worthwhile. But the money runs for ending on the return phase before remaining significantly diminished, a development may not always come back a revenue and hence, it would be real investment.
Does not consider a project's return on investment: Several firms involve money assets to go above a specified obstacle related to cost of pay back, if not the development is refused. The return technique does not reflect a plan's percentage of arrival.
Task 3
In the present times, there are many questions related to the real options and many scholars have always debate views about these real options to be analyzed, debate concerning about the intricacy of the real options and about their demonstrating in the real world of finance. There are so many well-known misunderstandings about real options that real options are that analysis that it is an academic impression which is used for making managerial decisions. Moreover, real options are implanted in management decisions on daily basis. Stewart, R. et al. (2004), they used the simple real options, NPV (net present value) and discounting cash flows, gives the perfect answer in decision making. Furthermore, the real options have also perfect concept for answering the financial strategic queries (Stewart, R. et al. 2004).
In the research paper of Stewart, R. et al. (2004), the real options, analyzed by a critical way. The authors in research, found many strategic challenges in research and development during planning the investment decisions. Also, the organization is facing the ambiguity during making research and development, the organization also, may found vagueness about the cost related activities. In addition, firm is also not sure about the outcomes of their research and development (Stewart, R. et al. 2004).
On the other hand, according Black Scholes Theory, the real options are moderately different from financial options. In contrasting, the real options do not have similar or fixed variables as financial options. Also, these financial options has some fixed variables named as strike price and termination stages, the financial options has many fundamentals which permits financial options to get analytically trade on contacts from runny marketplaces for primary properties, where they are not in form of real options.
According to Brealey and Myers 1996, McAneney and Berkman 2000, the real options are those privileges, which are not having any kind commitments, fixed funds particularly related to mode of entry in the marketplace, and those strategic decisions which are related to research and development. These also, ensures the management to reduce the uncertainty in the market and risk in the costs which are invested (Brealey and Myers 1996, McAneney and Berkman 2000, cited in Stewart, R. 2004). At some extent, the real values and options enables the organizations about their competitors in market, also teach them a lesson about their success and failures. Basically, the real options lie between the flexibility, which has been given (Stewart, R. 2004). As concerning the flexibility of the real options, enables a usual set of tools which helps the organization to tackle the flexibility of economic values (Stewart, R. 2004).
There is also a question arises, how the flexibility helps or what is the use of flexibility in terms of economical real options? To answer this, the units of uncertainty investments has to understand first. No one, can identify the uncertainty of investment, they can only be solved by time and how long time may takes, nobody knows, therefore, the flexibility is option in which management has rights without any interference of others, to make some decisions which may help to avoid the risks and taking risk as the positive side (Stewart, R. 2004). For instance, if a project able to succeed in its early stage then the management or investors may think to invest more or in quicker way (Stewart, R. 2004).
Surrounded opportunities, the organizations may permit some procedures through which they may be able to modify the design while taking the info from feedback which gets from the investment’s times. It also able to define, the single success key factor of the real option is to think expressive contexts which provides the support to the premeditated planning for investment making decisions by the management Stewart, R. 2004). It provides the standards to the planning, but more significantly, it delivers the destructive strategic valves which could impact future value decisions also (Stewart, R. 2004).
According to Stewart, R. 2004, they divide the flexibility of the real values into three level of structure named as Conceptually, analytical, and empirical (Stewart, R. 2004).
Furthermore, the conceptual framework is again dividing the real options into four genetic levels for decision making. The first division is to defer which is defined as take time for feedback first then make the decision. Second level is to Switch, in this option firm takes decisions to change the investment, and has right to use the alternative resources, also provide safety among the negative impacts against the investments. Next division is to expand, in this type of real option in conceptual generic option is defined as when a project gains success during the initial stages then the organization or management may think to expand the project by research and development, and they may also invest more to explanation of their projects. Finally, to shut down or to abandon. It is defined as to take all investments back and shut down all running projects by organizations (Stewart, R. 2004).
The second division is analytical option have been studied from 1980s, there are many studies have conducted by using various compound options has been consider for making investments in projects. This level is responsible for uncertainty any high risk for many projects related to pharmaceutical industry and its products, oil industry and mining projects as well (Stewart, R. 2004).
According a scholar named as Trigeorgis (1996), he suggested the analytical models have very restricted because there are many complex options has for making investments to operate the projects, whereas it also organizations face many difficulties while working on investments by analytical level of real options (Trigeorgis 1996, cited in Stewart, R. 2004).
Finally, the last level is Empirical, which enables organization to believe that the real options are disproportionally at a low level (Stewart, R. 2004).
As the PW communications company is also having very flexibility in the real options according to data collected by the calculations. According to McKinsey (2000), the real option pricing model has six forces to establish the strategic framework in the organizations. These six forces related to price of stocks, fixed costs, risk and uncertainty for the future, expiry of time, dividends, and risk-free interest rates. As from the calculations the company´s sales of stock have been continuously increased from £156 in 2021 to £182.5 in 2025. Therefore, company´s PV of cash flows projected from chances of investment options is acquired. Concerning, the company´s fixed costs is increasing rapidly, thus, the company able to get life expectancy from the fixed costs accumulating the present value and investments, whereas the growth rate of the company has uncertainty and risk related to the investments and cash flows belongs to assets of the company, as it has been seen that in the year 2015, company has 16.19% of growth rate, in the next year it has been increased approximately 3%, and in 2017 the company´s growth rate was on peak with highest growth rate with 28%. However, in the year 2018 and 2020, the company might be faced uncertainty, and risk on the cash flows, therefore, the growth rate was below 10%. The next force is related to delivery of product on time, may also be determined by technology, after taking all feedbacks, the company has to make innovations and changes in the product, and final product also deliver on time before it expires. Furthermore, considering the dividends, the company face an increase in extra expenditure on the new machinery, more advertising, and high tax rates to beat their competitors in the market, company face increased dividends every year. Finally, the company able to gain free rates on the interest after product (McKinsey, 2000).
Task 4
According Fletcher, H and Smith, D. (2004, p2), Economic value added (EVA) is not a system of measurement to study the finance but it also enables some planning, how to execute the procedures to make a strategy for calculating the performance of the various aspects of the EVA model in detail. Some of the difficulties also seen in the assigning the variables, suggested by the organizations. According to Haspeslagh et al. (2001), they have been examined in their research that value based has labelled as a successful variable used by organization for assigning the financial values at various aspects which impacts the profit. The company assimilate their complete process into a one single system to measure the financial performance, and this research was based on frontier managers and employees to make them full concept clear (Haspeslagh et al. 2001, cited in Fletcher, H and Smith, D. 2004).
The Balanced score card is the next variable in EVA model according to Fletcher, H and Smith, D. (2004). It is defined as the organization has some kind of instruments which has been used to evaluate key functioning by using the surveys. According to Kaplan and Norton (1992), they defines the balance score card has four tools which helps to learn different perspectives, such as customers, internal business actions, innovation learnings and financial, which help organization and administration to create many unified approaches. These terms of balance score card enables the organization about the feedback for research on the customers, also they know how their customers believe in their process encouraging them to participate in developing the financial performance of the company, as well as company take the feedback about the taste of the customers and collect the survey on their satisfactory level. The next term in which the company able to get survey about the internal business activities in the firm itself, which further defines company makes the survey about the quality the products, which provide, also the administration able to know about cost and expenditures as well. The level is innovation and learning, by using this tool company able to calculate the sales from the new products, moreover, they came to know about the innovation skill of the employees of the company. Finally, the financial statistics which ensure the shareholder wealth, and place of the firm in the marketplace (Kaplan and Norton 1992, cited in Fletcher, H and Smith, D. 2004).
Moreover, the balance score card test the various value drives such as lagging and leading, measures the mandatory and non-mandatory financial performance, mathematical and non-mathematical performance as well. As the company enables to launch these in efficiently, they may be able to examine the key aspects which impacts the implementation of this framework. The AHP (analytical hierarch process), is defines as procedures through which company able to make multi-level decisions to make links among the presentation and execution of the decisions by the supervisors. According to Pineno 2000, Liberatore et al. 1997, AHP is applied to connect between qualitative and quantitative measurements to make an assimilated structure (Pineno 2000, Liberatore et al. 1997, cited in Fletcher, H and Smith, D. 2004). AHP in the EVA model is used to solve various business obstacles, moreover it is very helpful in earmarking the primary and second sources of income or profits for the company, helping in making the strategies, exploring the effects of strategy while solving the disputes between employees or organizations (Saaty 1996, cited in Fletcher, H and Smith, D. 2004).
According to Saaty 1996, demonstrated the resulted which is used to organizing and evaluating the complication to solving problems in multi-criteria decisions makings (Saaty 1996, cited in Fletcher, H and Smith, D. 2004). Fundamentally, AHP is a process through which organization tried to crack down the difficult circumstances in to smaller element, further, they should has to assign them in a hierarchical manner, and organizations make sure that during assign the hierarchical order they do not have any complexity (Saaty 1996, cited in Fletcher, H and Smith, D. 2004). This variable also helps to apply a well strategic plan, to recognize the different value drivers and their relevant models too, through which the firm increases the positive objective value. The second feature of AHP is to make squads which organization able to magistrate the value drivers to accomplished the aims of EVA model, which further used in enhancing the performance of firm (Saaty 1996, cited in Fletcher, H and Smith, D. 2004).
Task 5
Yes, I am agreed with the statement of Linda Webster, we must use discounting factor to make capital structure more effective in future. As we look the literature, according to Ehrhard and Bringham (2003), cost of the business is created by PV (present value) as projected to the future cash flows which is engendered from assets, by low-priced at the firm´s weighted average cost capital (Ehrhard and Bringham 2003, cited in Chowdhury, A. and Chowdhury, P., S., 2010), from this the WACC impacted immediately on the valuation of the organization (Johannes and Dhanraj, 2007, cited in Chowdhury, A. and Chowdhury, P., S., 2010).
According to Messbacher, (2004), to debts and equity is used to find the right valuation of the investment composition of the firm and it helps to boost the investor´s capital, whereas, the WACC is employed by the company´s cost by discounting outlook cash flows. Messbacher, (2004), also, examined that if we can be able to reduce the WACC the value of increases automatically (Messbacher, 2004, cited in Chowdhury, A. and Chowdhury, P., S., 2010). Many authors examined by taking ratios to calculate debt and equity as a indicator, through increase in leverages leads to high risk of liquidity or bankruptcy of the value of the firm, therefore, administration constantly consider the benefits of foreigners (Leland and Pyle, 1977, cited in Chowdhury, A. and Chowdhury, P., S., 2010).
Moreover, Modigliani and Mill (1963), studied that value of organization is growing purpose of control due to income tax or other traffic which are deducted from the benefit costs at the corporate business sectors (Modigliani and Mill,1963, cited in Chowdhury, A. and Chowdhury, P., S., 2010).
Initially, practical testimony upon the trade-off theory proposed by Bradley, Jarrell, and Kim, (1984),
produced matched outcomes Early empirical evidence on the trade-off theory produced combined outcomes (Bradley, Jarrell, and Kim,1984, cited in Chowdhury, A. and Chowdhury, P., S., 2010). Nevertheless, latest experiments assessing the investment formation answer towards transformation concerning commercial income tax disclosure support confirmation advocating the trade-off theory (Givoly et al., 1992; Mackie-Mason, 1990; Trezevant,1992, cited in Chowdhury, A. and Chowdhury, P., S., 2010). Myers (1984), argues that the trade-off theory, additionally neglects to calculate the widespread amount of cross-sectional and period difference of monitored debt ratios (Myers,1984, cited in Chowdhury, A. and Chowdhury, P., S., 2010).
Coming back at stock rises used for every statement of issuer trade deals. Generally, 55 percent of the difference in supply proclamation time resumes is described (Masulis, 1983, cited in Chowdhury, A. and Chowdhury, P., S., 2010). Below certain circumstances capital structure does not disturb the cost of the company. Dividing a stock into several combination of dividends concerning to liability, bonus and investment immediately enhances cost of the business (Gemmille, 2001, cited in Chowdhury, A. and Chowdhury, P., S., 2010).
According to Modigliani and Miller (1958) findings is currently broadly recognized. However, investments, undoubtedly can be significant. The most important rationales, why its questions still involve income tax, changes in data and organization expenses. Concepts of prime investment building difference in their comparative importance on, or explanations of, these issues. The trade-off theory highlights income tax, the striking imperative hypothesis accentuates distinctions in evidence, as well as the unrestricted cash flow concept underlines group expenses (Modigliani and Miller 1958, cited in Myers, C., S., 2001).
Overall, organization´s liability ratios are minimal or adverse while productivity as well as commercial risk remains very excessive, whereas, Vague properties are also linked together with less debt ratios. For illustration, marketing, and advertising-intensive firms such as Procter & Gamble must conventionally running by low-slung debits. Moreover, their benefits arise predominantly since from quantifiable resources. Companies along with significant development prospects similarly have a tendency to carry out minimal debt ratios (Long and Malitz, 1985; Smith and Watts, 1992; Barclay, Smith and Watts, 1995; Barclay and Smith, 1999, cited in Myers, C., S., 2001).
According to Stulz (1990), studied that liability can come up with equally a positive and negative impact upon the cost of the company, at the same time during the absenteeism of business dues as well as insolvency expenditures. He expands a pattern through which debits may be able to mutually relieve the more investments difficulty, besides the less investments trouble. Stulz (1990), believes that executives have no fairness proprietorship in the corporation in addition to obtain efficiency through managing a bigger organization. The “superpower of manger” might inspire the self-involved bosses to carry out undesirable current cost design. To overcome this challenge, stockholders influence organizations to issue debt. Although, if companies have been compelled towards repay outdated cash, then it might be necessary to skip positive present value ventures. Consequently, the optimum debt arrangement stays decided with evaluating the best possible organization´s cost of debt as well as the organization’s cost of managerial judgment (Stulz, 1990, cited in Chowdhury, A. and Chowdhury, P., S., 2010).

References

Fletcher, H and Smith, D. (2004) ‘Managing for Value: Developing a Performance Measurement System Integrating Economic Value Added and the Balanced Scorecard in Strategic Planning’, Journal of Business Strategies, Vol. 21, Iss. 1, p1-17 accessed from https://www.semanticscholar.org/paper/Managing-for-Value%3A-Developing-a-Performance-System-Fletcher-Smith/65b831c89e972ca95d9a6dff7ae565cd70f42822, online

Stewart, R., Studley, J., Stokes, D., Vassallo, P. and Wells, P. (2004) ‘Understanding the options in Strategic decisions and investments’, The Journal of the Securities Institute of Australia, Iss. 2, Winter, p2-5 accessed from https://www.finsia.com/docs/default-source/jassa-new/jassa-2004/2_2004_options_investments.pdf?sfvrsn=eb2cde93_6, online

McKinsey (2000): The real power of real options, published on read option, published on 1^st June, accessed from https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/the-real-power-of-real-options#, online

Woodruff, J., (2019): Advantages & Disadvantages of Payback Capital Budgeting Method, published on February 4^th, accessed from https://smallbusiness.chron.com/advantages-disadvantages-payback-capital-budgeting-method-14206.html, online

Myers, S.C. (2001); Capital Structure, The Journal of Economic Perspectives, Vol-pp-15, 81-102.
Accessed from http://dx.doi.org/10.1257/jep.15.2.81, online
Chowdhury, A. and Chowdhury, P., S., (2010): Impact of capital structure on firm’s value: Evidence from Bangladesh, BEH - Business and Economic Horizons, Vol- 3, N-3, accessed from https://academicpublishingplatforms.com/downloads/pdfs/beh/volume3/201103201454_10_V3_BEH_BANGLADESH_AnupChowhury_et_al_d_ac.pdf, online

Appendix:

Cost of equity = Expected dividend/ price + dividend growth rate
Market value of equity = 4.70
Current dividend per share = 1,181,000 /6000000
= 0.1968
Amount of equity = 6,000,000 x 4.70 =28,200,000
Cost of equity = Expected dividend/ price + dividend growth rate
= 0.1968 x 1.1610 / 4.70 + 0.1610
= 20.96%

Cost of debt = interest expenses x (1-t)

Cost of debt
N = 5 x2 =10
FV= 100
PV = 90
Pmt = 100 x7%/2 = 3.50
interest expenses = 2 x 4.7813% = 9.5626%
Cost of debt = interest expenses x (1-t)
= 9.5626% x (1-0.25)
= 7.17195%
Amount of debt = 4,000,000 x 90/100 =3,600,000
Sales revenue= sales unit*Price per unit
Total cost= total fixed cost+ total variable cost
Total production cost= sales unit* total cost
EBIT= sales revenue- advertisement cost
Operating cash flow= EBIT-tax
Present value= cash flow*PV discounting factor

NPV = (Cash flows)/(1+r) i

i- Initial Investment
Cash flows= Cash flows in the time
r = Discount rate
i = time

IRR = Lower rate + positive NPV/ (sum of NPVs) x difference in rate

= 0.16 + 90932 / (90932 +467800) x 3.40%
= 0.16 + 0.0055
= 16.55%
WACC = 6168910.2/ 31800000
= 19.40%