MADISON PLC CAPITAL DECISION

MADISON PLC CAPITAL DECISION

Background Information

Making capital decision requires consideration of many factors that which include the financial requirement of the investment and the sources of the funds. As illustrated below an organization can get the required funds from various sources which gave their disadvantages and advantages.

  1. Sources Of Fund To The Organization

Loan from financial institutions: banks and other financial institutions lends money to the organization for interest. Benefits of this source of financing are that it is easy to get as long as the company has sufficient collateral, sometimes it can involve a long grace period, it gives a company tax advantage and is paid in installment (Hwang and Yoon, 2012). However, loans come with an interest which increases organization’s expenses and lower profitability. It is recommendable for an organization to use the loan fund for the activities that it is meant for to facilitate its servicing.

Issuing shares: a company can give right issues or issue new shares. This gives the company an opportunity to get fund from either new or existing shareholders. Benefits of this source of the fund include no interest obligations, no mandatory dividend payment, and a company can get a sufficient fund. However, issuing shares is very length procures that requires an entity to meet a lot of requirements and can cost the company huge legal and other costs. Shares can only be issued when the company has met certain thresholds used by regulators and investors to analyze the value (Xu, 2015).

Retained earnings: internally generated income are apportioned to the shareholders regarding dividends, and some are retained for expansion. Retained earnings are cheap, does not have any process of acquiring and a company does not have to undergo various scrutiny to be allowed to use (Graham, Harvey, and Puri, 2015). However, internally generated fund can be limited and insufficient to meet the expansion requirements of the organization and it is used at the expense of the shareholders dividend which can cause friction with the shareholders.

Grant and donation: governments, municipality, and developmental organizations can give donations and grants to an organization (Xu, 2015). Donations are freely given, but one disadvantage is that the organization has to meet certain requirements to qualify for it. An organization should only use the grant for the purpose for which it was given for.

Venture capital: venture capitalist injects their money into the project that they project to have high returns in the future. Organizations can use venture capital fund to expand its operations. Venture capital is cheap and involves no much obligations, but it is hard to get (Xu, 2015).

Other sources of a fund that can be used by the organization include cloud funding, lease, hire purchase, franchising, and holding a fundraising (Graham, Harvey, and Puri, 2015). It is recommendable that the organization should use the source of fund that will help it to meet its financial needs while at the same time filling its mission and lowering the level of encumbrances.

  1. Efficient Working Capital Management

By definition, efficient working capital management can be looked to like the way in which the company strikes a balance between its current assets and current liabilities to ensure that it can be able to pay for its obligation when they fall due. This is an imperative and important to ensuring the financial health of an organization. The best indicator of the business management is the ability of this business to utilize its working capital to obtain a balance between the liquidity, growth and profitability. To ensure that the organizations efficient working capital management, it has to adopt an accounting strategy which focuses on having sufficient level of both current assets and current liabilities (Devigne, Manigart and Wright, 2016). Usually, the working capital is the prevalent metric for the organization’s efficiency, liquidity, and its entire health. Working capital reflects various activities carried out by an entity which includes revenue collection, debt management, inventory Management and payment to the suppliers.

Inadequate working capital can lead financial insolvency which can lead to the liquidation of assets, bankruptcy, and other legal issues. This underpins the importance of an organization to ensure that it has maintained an efficient working capital. Working capital management is meant to ensure that the organization meets its short-term obligations, and it is also meant to ensure that it has improved its earnings. Working capital management involves the use of different financials ratios that include inventory turn never, current ratio, acid test ratio, and collection debt ratio. These ratios play an instrumental role in helping the organization to identify areas in which the company should improve to boost profitability and liquidity (Silvia, 2011). As such efficient working capital helps an organization to improve its cash flow, support its daily operations and leads to the stakeholders’ satisfaction which is core to the growth of an entity.

Investment Proposals Analysis

Projection evolution can be carried out using different methods and factoring in various elements. Widely used investment analysis are the discounted methods which include net present value (NPV), internal rate of return (IRR) and sensitive analysis. NPV shows the present value of all the expected future cash flow from a given project. A positive NPV indicates that the cash inflow will exceed the total cash outflow (Sarngadharan, and Kumar, 2011). On the other hand, a negative NPV shows that the project should not be undertaken within the period in which it is projected to take place. The evaluation of the Super Draft software project reveals that it is expected to generate an NPV of £2, 909, 000 as illustrated in Table 1.0 in the Appendices.

This shows that the project will generate positive gains for the company and thus it is economically viable (Sarngadharan, and Kumar, 20111). On the other hand, the Platform Draft software project is expected to generate an NPV of £2, 570,570. Like the Super Draft software project, Platform Draft software project is projected to have a positive NPV as illustrated in Table 2.0 (Appendix 2). When comparing the NPV of the two projects the project with the highest NPV is given priority over the others because it shows that the project will have high gains compared to the other project. In this case, the Super Draft software project has a high NPV than the Platform Draft software project and thus it is more appealing to the Madison Company. As such, relying on net present values of the two projects it is advisable that the company should choose the Super Draft software project.

The IRR for the Super Draft software project is 19% (as shown in Table 1.0). With a cost of capital of 14% the company has a 5% difference between the IRR and the cost of capital. Usually the higher the difference between the cost of capital and the IRR the higher the probability of growth the project is Super Draft software projected to have (Northcott, 2008). The Super Draft software project IRR shows that it is likely to have a 5% growth. On the other hand, the IRR for the Platform Draft software project is 10%. This is lower the project’s cost of capital of 13%. As such considering the internal rate of return, the Super Draft software project is more favorable for the Madison Company, because the company net present value is expected to be zero at a higher rate than that of the Draft software project.

The sensitive analysis of the projects (as illustrated in table 3.0 and 4.0 in appendices), shows that Draft software project is more sensitive to change in discount rate than the Super Draft software project. A higher sensitive project indicates that it has a high risk of losses or more gain in case one of the factors changes (Leong, Tan and Leong, 2014). For the Super Draft software project, the change of the cost of capital to 10% leads to an NPV of £ 3,913,740, which is a relatively small change compared to the Draft software project, where a change of cost of capital to 11% pushes the project’s NPV to £3196000. The IRR for the two projects changes to 23% and 12.42% for the Super Draft software project and Draft software project respectively following the change in the cost of capital to 10% and 11% for the two projects. This shows that the Draft software project is relatively more volatile and thus Madison should choose the Super Draft software project is more stable. The overall analysis of the two software projects leads to the recommendation that with only £5.5 million of funds, Super Draft software project is more feasible for the Madison Company compared to the Draft software project and as such the company should seek to invest in it.

Use of Use Break-Even Analysis

Break-even analysis would help Madison company to know the number of software and the revenue that it should generate to cover all the developmental and operational expenses without making any profit. This helps the company to set its target, strategies on the ways in which it can improve its sales, and set a safety margin below which it will be operating on at a loss (Jong and Gardner, 2013). The aim of every company is to ensure that it does not make a loss and break even analysis helps the company to know the number of units that it should sell and the amount of money that it should seek to generate if at all it wants to have a profitable and sustainable business.

A good example of breakeven analysis case is assuming that Madison decides to invest in the Super Draft software project. Assuming that the company sells one unit of the software at £ 25, 000, the total fixed cost (rent, salary, and other fixed costs £100,000 and the variable cost per unit is £ 20,000, the break-even analysis of the company would be given as follows:

Break-even units = Fixed cost / (Price per unit – Variable cost)

= £100,000 / (£ 25, 000 – £ 10, 000)

= 7

This means that the company………………………………..

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