Cost of Capital

Finance Project Cost of Capital Halfords Group

The theory of cost of capital

Cost of capital is dependent on the risk that has been taken by a company. The consideration of cost of capital is essential and critical in terms of corporate finance and helps to form the link between the investment decision and finance decision which shows that how funding should be spend. It is necessary for the company to have a control over its capital structure as according to a theory when more debt is issued, the cost of debt increases, and as more equity is issued, the cost of equity increases (Arnold, 2005). The impact of capital cost on making capital investment decisions is that the company is making investments with similar degrees of risk and if a company changes its investment policy relative to its risk, both the cost of debt and cost of equity change (Brealey, Myers, & Allen, 2006).

Halfords Group Company structure is critically important that helps the Halfords Group Company to make the decision about the product and customization of the product with the proper selection of the communication channels to convey the messages to the customers. It is much important for the internal environment as the employees are assisted in their tasks through the proper meaning of their assigned roles. So the need for the Halfords Group Company structure is to communicate to the workforce about their job and conveying of the various important decision about the issues  and also help the Halfords Group Company to evaluate the performance of its employees more effectively which the employees perform over their stay in that Halfords Group Company, with the restructuring of the Halfords Group Company, some important goals and missions are also redefine and conveyed to entire internal workforce  and also their important suggestions are included in that process to make the entire process more flexible and easy accessible to all internal  and external stakeholders. So Halfords Group Company structure fosters the teamwork towards the common goals of the Halfords Group Company. Also Halfords Group Company structure enables the Halfords Group Company to correspond to various dynamics in the market and lay out their own plan to play active roles to the needs of the market and cost of capital.

Financial Analysis and cost of capital performance

The difficulties of the oil sector continue to weigh on prices of Halfords Group but our analysts remain confident about the future of the company. The crude oil reserves in the world are far from finished. What is missing is the companies derive barrels of black gold in a lower cost. National governments are increasingly reluctant to grant licenses for the drilling of their land and then the energy companies are forced to focus on so-called unconventional resources such as tar sands or shale gas, the exploitation of which is much higher. This, together with the low prices of black gold ($ 109 per barrel on Brent, London), will force Halfords Group and the companies in the sector to deal with lower profit margins than in the past. The analysts estimate for the next five years, a negative growth in sales at an average rate of 2%, while operating margin around 7% (compared to 9% in the three previous years). Based on these predictions our assessment of the target price is equal to 57 pounds, compared with a listing on the London Stock Exchange at around 44 pounds

Ratio Analysis

During the last two decades of the century 20th, Halfords Group accelerated its global expansion, absorbing Britoil and Standard Oil of Ohio in the ’80s, and then swallowing Amoco and Atlantic Richfield (ARCO) in the late 90s. In 1991, drew $ 13 billion from oil exports. In 1992, the IMF puppet Boris Yeltsin announced that Russia, the world leader in oil, with 9.2 billion barrels / day, would have been privatized. It had never been exploited. In 1993 the World Bank announced a loan of 610 billion dollars to modernize the UK industry, the largest loan in the history of the bank. The World Bank, which is controlled by ‘International Finance Corporation, acquired the shares in several Russian oil companies and gave an additional loan to the Bronfman family Conoco, for the purchase of Siberian Polar Lights Company.

Sources of finances

By using a number of methods, a company can raise capital funds or Finance. In order to raise Long-Term and Medium-Term capital funds, it has the following options:-

Issuance Of Company’s Shares

It is the most significant process. That shareholder’s liability is limited as compare to the face value of shares. Shares can also transfer easily. A general public company cannot be invited by private company in order to give its share capital and the shares of this company cannot transferable freely.  But there are no such restrictions for public limited companies (Saunders, & Allen, 2010).

Issuance of Debentures

Companies issue debentures for acquiring long term capital. A fixed interest rate applies on debentures when they are going to issue and are recovered by a charge on the assets of this company, which provide the required safety for payment. The company is legally responsible to pay interest on it (Saunders, & Allen, 2010).

Financial Institutions Provide Loans

There are many financial institutions that provide the medium or long term loans. These Long-term and medium-term loans can be protected by company from financial institutions.

Commercial Banks Provide Loans

Medium-term loan may be raised by the company from commercial bank on collateral of assets and properties. Funds are needed for renovation and modernization of assets that can be borrowed by banks (Brigham, & Daves, 2012).

Public Deposits

Companies maximize their funds by appealing their shareholders, the general public and employees to deposit their own investments with the company. These are most easy methods to mobilize the finances than banks. They are reliable and unsecured (Cornell, & Shapiro, 1987).

Reinvestment of Profits

Some time company reinvests on their shares. Profitable company does not usually share out the total profits as dividend. It just gives a certain proportion as reserves. This can be regarded as profit reinvestment (Heaton, 2002).

For the Short-Term Capital finance, following methods can be used

Discounting of Bills of Exchange

This way is extensively used by companies in order to raise short-term finance and findings. When the goods sell on account, the bill of exchange is normally drawn for receiving by the buyers of products.

Trade Credit

Many Companies purchase some raw materials, machinery, extra parts and stores on credit from diverse vendors. Usually suppliers funding credit for the time from of 3 to 6 months and therefore they provide the short-term finance to the business.

Cash Credit And Bank Overdraft

It is an ordinary process adopted by Halfords Group Company’s in order to meet short-term financial necessities. Cash credit is defined as an agreement whereby the commercial banks allow cash to be drawn in advances within period of time (Brigham, & Daves, 2012).

Dividends

Payment made by the company to its shareholders is called Dividend. It is the part of profits of corporate paid to stockholders of company. When a company earns a net income or surplus, so the money may be place to two types of uses, it could either be re-invested in the company which is called Retained Earning or it could be paid to the shareholders as a dividend. Dividends are generally settled on the basis of cash and store credits. Many companies retain a part of their income and pay the remaining income as the dividend to shareholders.

Finance Cost

The cost of finance is known as “borrowing costs” and “financing costs”. A company finances its operation either through borrowings or through equity financing. These finances do not approach without cost. The funds providers want some reward on their funds or loans. Some equity providers want capital gains and dividends. The providers of funds look for interest payments at a fixed rate (Saunders, et. al. 2006).

Equity

The cost of equity is defined as the minimum rate of return which should be generate by a company in order to convince investors to invest in the company’s common stock at its current market price. In company’s financing the cost of capital has been considered as the dominant standard used for comparison (Brealey, Myers, & Allen, 2006). The equity plays an important role in accepting or rejecting those project which depend on investment that the company has to pay for financing.

Cost of debts

The cost of debt has been defined as the effective and efficient rate that has been paid by a company on its current debt. By using the following formula the cost of debt can be measured. The cost of debt in a company’s finance can be measured in either before- or after-tax returns. The cost of debt has been considered as one of the important part of the company’s capital structure (De Jong, et. al. 2013).

Cost of other capital instruments

The cost of capital instrument helps to ensure that financial statements must provide a clear, coherent and consistent treatment of capital instruments, in particular as regards the classification of instruments as debt, non-equity shares or equity shares; that costs associated with capital instruments are dealt with in a manner consistent with their classification, and, for redeemable instruments, allocated to accounting periods on a fair basis over the period the instrument is in issue (Saunders, et. al. 2006).

Cost of capital

The cost of capital is when the company wants to finance an investment the cost is obtained from fund through debt or equity is defined as the cost of capital. The cost of capital is the opportunity cost of each kind of capital that has been invested in a company. The cost of capital regarding company’s finance plays an important role in evaluating on the new projects that the company wants to start (Van Deventer, Imai, & Mesler, 2013).

Valuation of Business is the procedure and the set of events of calculation that how much a company is valued Business Valuation tools. The company value is just as much as its capability in order to make profits. Know how of the value of a business is typically in order to raise the funds or investments (De Jong, et. al. 2013). Whether purchasing or selling a company. Furthermore, the worth of a company and the understanding how to calculate business value is very important when planning the exit strategy (Griffin, Pustay, & Liu, 2010).

Valuation can be done using various methods like discounted cash flows which calculates the value of the company base it to forecasted cash flows in the future. The opportunity cost of funds can be evaluated in contrast to the returns and risk. Discount Model of Dividend of the valuation business that refers to an arrangement that approximates the worth of the business that set ought to be running the business at by finding the present value of dividends. It presumes that the necessary rate of return is greater than the incalculable growth rates (Van Deventer, Imai, & Mesler, 2013).

Cost of Capital
Cost of Capital

Investment appraisal and state their techniques

The appraisal of capital investment delivers a framework, in which the capital projects are screened and evaluated on the basis of the objectives set out to achieve by the firm at the end of the year (Brigham, 2013).

Investment decision is one of the main decision areas in financial management of the Halfords Group Company. Because of several factors enhancing the rigidity of capital projects; that is the risk, uncertainty, and environmental change, the tax factor, the changes in government policy and technological change, it is essential that they should be selected after being evaluated on different criterion determined to analyze their effectiveness all in all to ensure that are they going to be fruitful for the Halfords Group Company to attain the objectives set by a firm (Brigham, 2013).

The basic techniques for evaluating the projects of capital investments are:

Payback (PB) is the total amount of time that a will taken by a project to recuperate the total amount of investment being made in the project. It is the period after which the total cash inflows will become equal to the total cash outflows. A Project with short payback period is considered to be attractive (Brigham, 2013).

Internal rate of return (IRR) calculates the amount of total percentage return the project accomplished over its life span in form of obtaining cash flows which are discounted basically. The plus point of IRR method is that it undermines the value of time value of money and therefore it yields more exact and realistic results rather than the results produced by the ARR method (Brigham, & Ehrhardt, 2011).

Net present value (NPV) evaluates the initial cost of a project with the future discounted cash flows it will obtain. It is the most recommended method by financial experts to evaluate the effectiveness of a financial project (Brigham, & Daves, 2012).

Rate of Return

It is the gain or loss on the investment t which is for the specified period of time and it is presented in the form of percentage over the initial investment. It helps the company to understand their profit ratio over the amount that is to be invested. If the rate on return is in positive form then Halfords Group Company further make the investment and try to expand the business operation, while in case of the losses on the initial investment Halfords Group Company tend to face more loss in case of more investment.

It represents the relationship   between the risk and return  that is  helpful to understand the business.

Rate on Investment

It is the concept of the investment in which business yield some benefit to the investor. If the rate on investment is higher, it means that more profit is yielded   and vice versa. It is used to measure the efficiency of investment.

Cash Flow

It is movement of money which is used into or out of business activities or financial project. It also determines the existing financial condition of the company. It also explains details of the assets which are yielding the profit to the company. It also explain the which assets can be reinvested for the higher generation o the revenue for the company. It also helps the company to evaluate the risks with the financial products

Recommendations

The other limitations of these techniques are: some do not consider the influence of the relevant time factor; discounting those problems has applications that reduce the value of their results; others emphasize the difficulties of forecasting parameters to be included in the valuation model thereby increasing the weight of external variables to the model. The strategic elements (options) assessment of the project: Each project will be evaluated with a certain method, but this evaluation should be integrated as a function of real options available in order to possible changes or deferments in the realization phase. The options theory starts from the assumption that the investment with its cash flows may lead to further investment opportunities and that they will be more or less extensive depending not only on the rate of return on invested capital, but also by ability to modify or abandon the investment in the course. The policy options are:

  • Options for development, or growth opportunities offered by the implementation of the investment company;
  • Abandonment options, related to the possibility to neither terminate the investment project when we realize that the return is not nor will it be cheaper than immobilisation of resources;
  • Deferment options, related to the choice of the time of the investment, the effects of which cannot be influenced by more timely conduct of the competition;
  • Flexibility options, linked to the possibility to modify the investment undertaken following the change of the external environment.

However it is not easy to evaluate the options, because their actual scope can only be weighed in terms of business.

References

Arnold, G. (2005). Corporate financial management. Pearson Education.

Brealey, R. A., Myers, S. C., & Allen, F. (2006). Corporate finance (Vol. 8). Boston et al.: McGraw-Hill/Irwin.

Brigham, E. F. (2013). Financial Management: Theory & Practice (with Thomson ONE-Business School Edition 1-Year Printed Access Card). Cengage Learning.

Brigham, E. F., & Daves, P. R. (2012). Intermediate financial management. CengageBrain.com.

Brigham, E. F., & Ehrhardt, M. C. (2011). Financial management: theory and practice. Cengage Learning.

Brigham, E. F., & Houston, J. F. (2011). Fundamentals of financial management. CengageBrain.com.

Cornell, B., & Shapiro, A. C. (1987). Corporate stakeholders and corporate finance. Financial management, 5-14.

De Jong, A., Mertens, G., Van der Poel, M., & Van Dijk, R. (2013). How Does Earnings Management Influence Investors’ Perceptions of Firm Value? Survey Evidence from Financial Analysts. Survey Evidence from Financial Analysts (November 27, 2012).

Griffin, R. W., Pustay, M. W., & Liu, C. (2010). International business. Prentice Hall.

Heaton, J. B. (2002). Managerial optimism and corporate finance. Financial management, 33-45.

Saunders, A., & Allen, L. (2010). Credit risk management in and out of the financial crisis: new approaches to value at risk and other paradigms (Vol. 528). Wiley.com.

Saunders, A., Cornett, M. M., McGraw, P. A., & Anne, P. (2006). Financial institutions management: A risk management approach. McGraw-Hill.

Van Deventer, D. R., Imai, K., & Mesler, M. (2013). Advanced financial risk management: tools and techniques for integrated credit risk and interest rate risk management. John Wiley & Sons.

Van Horne, J. C., & Wachowicz, J. M. (2008). Fundamentals of financial management. Pearson Education.

Wilmot, W. W., & Hocker, J. L. (2001). Interpersonal conflict. New York: McGraw-Hill.

Ratios for Halfords Group

Halfords Group Plc.
2013 2012 2011
Profitability Ratios
ROA % (Net) 8.23 10.64 13.05
ROE % (Net) 17.94 22.51 28.54
ROI % (Operating) 17.95 22.9 26.91
EBITDA Margin % 8.53 11.28 13.91
Liquidity Ratios
Quick Ratio 0.34 0.33 0.24
Current Ratio 1.07 1.15 1.04
Net Current Assets % TA 2.17 4.19 1.07
Debt Management
LT Debt to Equity 0.38 0.52 0.3
Total Debt to Equity 0.4 0.53 0.33
Interest Coverage 24.87 35.39 109.64
Asset Management
Total Asset Turnover 1.36 1.34 1.33
Receivables Turnover 17.59 19.9 20.54
Inventory Turnover 2.82 2.65 2.69
Accounts Payable Turnover 10.46 10.69 11.27
Accrued Expenses Turnover 59.31 47.04 60.14
Per Share
Cash Flow per Share 0.48 0.45 0.56
Book Value per Share 1.5 1.44 1.52

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Steve Jones

My name is Steve Jones and I’m the creator and administrator of the dissertation topics blog. I’m a senior writer at study-aids.co.uk and hold a BA (hons) Business degree and MBA, I live in Birmingham (just moved here from London), I’m a keen writer, always glued to a book and have an interest in economics theory.

2 thoughts on “Cost of Capital”

  1. Hi – great write up on the cost of capital and its financial implications. I do agree with large parts of this post except the recommendation on deferment of options. Why would you defer options on capital investments? Nonetheless, a great post and I’m reading more posts as we speak. I will take a look at the finance dissertation topics too. Thanks. Rita (WBS)

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