1 Intro to Financial Management of the Organisation Week 12 WACC & Revision

2 Weighted Average Cost of Capital (WACC) Based on last weeks calculations of cost of capital 16.67% Irredeemable 11.21% Redeemable 11.35% Assume a capital structure of..

3 Capital Structure 3m £1 nominal ordinary shares = £3m 12% irredeemable loan notes = £2.5m 10% loan notes redeemable 5 yrs =£2m Total Capital Employed = £7.5m Percentage of total capital Ordinary shares = 40.00% Irredeemable loan = 33.33% Redeemable loan = 26.67%

4 Costs of capital – per calculations Ordinary shares = 16.67% Irredeemable loan = 11.21% Redeemable loan = 11.35% WACC = cost of ordinary shares x proportion of capital employed) + (cost of redeemable debt x proportion of capital employed) + (cost of irredeemable debt x proportion of capital employed)

5 WACC The result of this is: (16.67% X 40%) + (11.35% X 26.67%) + (11.21% X 33.33%) = = % This will be the interest rate to adopt when appraising the viability of a project

6 Revision Question – NPV & IRR Spaniel Ltd is about to commit resources to a capital project. The alternatives are "X" and "Y". The capital outflows and expected cash inflows of the 2 competing projects are listed below. "X""Y" £000£000 Year Year Year Year Year You are told that the company's cost of capital is 10% and you are required to: I) calculate the Net Present Value for both projects ii) calculate the Internal Rate of Return of project "Y".

7 Note at 20% NPV is still positive "X" £000DF 10%PV Year Year Year Year Year NPV81.3 "Y" £000DF 10%PVDF 20%PV Year Year Year Year Year NPV129.9NPV5.4

8 No matter – IRR calc 10 + [129.9/(129.9 – 5.4)] X 10 = 10 + [1.04 ] X 10 = = 20.4%

9 Ungulate Ltd – manufacturer of the Yak – Std costing/variance Materials Standard Use 4.00 £3.00 per Kg Labour Standard hours 3.00 £6.00 per hour Budgeted production 3,000 units ACTUALSDetails elicited after production run Output 3,200 units Materials 13,600 Kgs cost £40,120 Labour 9,000 hours cost £55,800 (200 hours idle)

10 Stage 1 – convert actuals to unit costs/find standard totals Calculations Standards Materials Total use = 4.00 X 3,200 = 12, Total cost = £3.00 X 12,800 = 38, Labour Total hours = 3.00 X 3,200 = 9, Total cost = £6.00 X 9,600 = 57, Actuals Materials Unit cost = £40,120/13,600 = £2.95price Labour Unit cost = £55,800/9,000 = £6.20wage rate

11 Stage 2 – Calc materials variances Materials Variances Total variance (Std use X Std price) - (Act use X Act price) = (12,800 X 3.00) - (13,600 X 2.95) = 38, ,120.00=1,720.00(A) Sub-variances Price variance (Std price - Act price) X Act use = ( ) X 13,600 = 0.05X13,600=680.00(F) Usage variance (Std use - Act use) X Std price = (12, ,600) X 3.00 = X3.00=2,400.00(A) 1,720.00(A)

12 Stage 3 – Calc Labour variances Labour Variances Total variance (Std hrs X Std wage rate) - (Act hrs X Act wage rate) = (9,600 X 6.00) - (9,000 X 6.20) = 57, ,800.00=1,800.00(F) Sub variances Wage rate (Std wages rate - Act wage rate) X Act hours = ( ) X 9,000 = -0.20X9,000.00=1,800.00(A) Efficiency (Std hours - Act hours) X Std wage rate = (9, ,000) X 6.00 = 600X6.00=3,600.00(F) 1,800.00(F)

13 Stage 4 (if required) – Calc Efficiency variances Efficiency Sub-variances Efficiency per above3,600.00(F) Idle hours variance Idle hours X Std wage rate = 200X6.00=1,200.00(A) Productive efficiency (Std hours - Productive hours) X Std wage rate = (9,600 - (9, )) X 6.00 = 800X6.00=4,800.00(F) 3,600.00(F)

14 Financial Reporting – key issues Pro formas – P&L Balance Sheet For Limited Companies Financial Reporting: Conventions Users Other statements Expanding the reports

15 Management accounts – key issues Standard Costing & Variance Analysis Traditional Costing Activity Based Costing Cost Volume Profit (CVP) Analysis Budgeting

16 Finance – key issues Capital Investment Appraisal Four methods – NPV, IRR, Payback Period, ARR Stock Markets Cost of Capital Financing and working capital