Role of Finance Management in Every Business Organisation

Financial Management

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TABLE OF CONTENTS INTRODUCTION........................................................................................................................... 1 TASK 1............................................................................................................................................ 1 Sensitivity and scenario analysis relating to capital budgeting techniques.................................1 A. Sensitivity analysis.................................................................................................................1 B. Scenario analysis.................................................................................................................... 3 TASK 2............................................................................................................................................ 4 Similarities as well as differences between CAPM and CML model......................................... 4 CONCLUSION................................................................................................................................6 REFERENCES................................................................................................................................ 7

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INTRODUCTION Finance is plays an integral role in each and every business organisation in order to exist and run in the industry. Without financial resources the entity can not establish in market and offers goods and services to the consumers. Further, to manage financial resources is also necessary with help of better and effective decision making. The present report throws light on three methods of decision making such as sensitivity analysis, capital budgeting and scenario analysis. It describes relation between sensitivity analysis and capital budgeting as well as scenario analysis and investment appraisal techniques. In the second part it shows differences as well as similarities among the capital asset pricing model and capital market line.

TASK 1 Sensitivity and scenario analysis relating to capital budgeting techniques Capital budgeting is a technique which helps to management in order to assess the viability of a project from two or more mutually exclusive projects. There are various methods of capital budgeting where the company is able to determine risk, return as well as future value of the potential investment. The various tools are such as net present value, internal rate of return, average rate of return, payback period etc (Coffie and Chukwulobelu, 2012). The investment appraisal techniques are related to the sensitivity as well as scenario analysis in order to manage financial resources of the company. Relation between the two analysis with reference to capital budgeting tools is given as below: A. Sensitivity analysis The analysis is helps to the managers in order to determine uncertainty of the project that whether investment will impact on financial performance of the firm in positive manner or negative manner. Sensitivity analysis is a process which consists changing in forecasting or make assumptions for analyse and derive project's finance impacts on the business performance. It can be known as an uncertainty analysis as well by which the company is able to determine future value of the firm (Capital Budgeting Techniques: Certainty and Risk, 2016). Most of the companies are use capital budgeting tools for undertake a project and take appropriate business decisions. On the other side capital budgeting is helps to the company in order to determine the Avail the top class finance dissertation topics ideas from the Professional writers of Instant Assignment Help at affordable price.

value of potential investment for the upcoming financial year. Apart from this it shows the time frame that within how many years a project will be recover. Simulation analysis is a mathematical model with help of cash inflows and outflows which are determined by capital budgeting techniques.

The mathematical model gives idea and analyse about the investment with help of probability distribution. The distribution is a statistical tool which used by the analyser in order to derive probability of a variable that another variable will be impact on the investment or not.

Capital budgeting is helps to calculate cash inflow in the future of the investment which is known as net present value. With help of the sensitivity analysis as well as capital budgeting methods the management is able to analyse about the investment before investing. Moreover, the simulation or sensitivity analysis is gives the information that how much probability a project has in order to generating cash flow by which the manager is able to take better and effective decisions. Hence, it can be said that sensitivity and investment appraisal analysis both are related up to greater extent in the company (Marshall, 2015). Relation between both the analysis or techniques for derive future value, risk and return of the investment as well as making business decisions is explained with a chart which is given as below:

Table 1ustration 1: NPV Simulation

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(Source: Capital Budgeting Techniques: Certainty and Risk, 2016) B. Scenario analysis It is a tool which helps to the management in order to take effective business decisions which lead to enhance level of profitability of the company. Scenario analysis is process for forecasting and determining the future or expected value of the investment or the portfolio. It considers overall scenario rather than considering a particular factor which affects to return of investment. Net Present Value helps to determine or estimate future value of potential investment while the analysis is presents about overall scenario such as economic condition, inflation rate, interest rate etc. It is a statistical tool by which the business entity is able to take better and favourable business decisions. In the present case suppose to inflation rate is considers for determine future value or net present value of the project after completion of the investment years (Izhakian, 2012). The NPV considers time value of money or time factor as well as cost of capital or discounting factor both. After calculating the PV factor for every year the investor is able to determine present cash flow for the future financial year. The project which has higher future value that will be consider to make investment or undertake in the business enterprise.

Further the discounting factor is based on the economic condition of the country where inflation rate, interest rate etc. are considers.

Furthermore, in terms of scenario analysis if inflation rate is increases then it impacts on interest rate as well as discounting factor of the project. When cost of capital get fluctuate then net present value of potential investment as well. Without value of cost of capital it is unable to determine net present value after completion of the project. The scenario analysis is based on every scenario of the country's economy, by which the management is able to know financial impact on the portfolio (Hsieh and Hodnett, 2012). It helps to take better business decisions by which the company can choose high profitable investment avenue and enhance profitability of the business. Hence, it can be said that both the tools such as capital budgeting and scenario analysis are related with each other for taking investment decisions.

TASK 2 Similarities as well as differences between CAPM and CML model Capital asset pricing model(CAPM) Avail the top class finance dissertation topics ideas from the Professional writers of Instant Assignment Help at affordable price.

Capital asset pricing model(CAPM) is used to identify the amount generated in form of return from an asset. This method is used in order to take decisions at the time of adding an asset to the portfolio. Additionally, the stated method is taken into consideration at the time of analysing the sensitivity of an asset during non diversifiable risk. It can also be said that it is a technique through which the rate of return is calculated against a risky asset. Adoption of this model is necessary as it determines the actual price of an investment. At the time of analysing risky assets the cash flow of an investments can be discounted to their present value. By extending this model, the fair value is calculated and compared with the actual market price.

Besides this, the cited model shows that the equity capital's cost can be evaluated with the help of beta. In order to select the appropriate portfolio asset pricing model is being adapted by the organization. Although, this model is used to access the risk and risk free capital asset pricing where the outcomes of both the methods are different. In case of risk and capital asset pricing, it is crucial to have good understanding of risk associated with an investment. However, a single security consist the risk related with the depreciation which results in the investment loss to the investor (Anghel and Paschia, 2013).

In context to above, the risk free rate is the expected rate of an investment which is assumed to carry zero involvement of risk. It is seen that the stated risk is adopted in short term which can affect the entire monetary system. In CAPM model, the beta value of the financial asset helps in measuring the associated systematic risk to the concerned asset. If the value of beta is 1 then the associated risk with share is same as of the capital market. There are certain advantages and disadvantages associated with the stated model. The major advantage of this method is that it assumes the investor has diverse portfolio as the market. It only considers systematic risk and ignores unsystematic risk of an asset. On contrary to this, the drawback of the model is that it is used for short term securities for the government. Additionally, the issue arises when the market is negative whi9ch leads to affect the overall return (Brown and Walter, 2013).

Capital market line model (CML) In relation to capital market line, the portfolio of market includes mixtures of assets associated with risk and risk free. However, the market value of the asset can be analysed with the help of capital market line which is derived by CAPM model. It helps in sporting the return expected form different kinds of risk. It can also be said that, CPM is a line which moves from the point associated risk free asset to the executable field. However, at the time of building Avail the top class finance dissertation topics ideas from the Professional writers of Instant Assignment Help at affordable price.

portfolio, it is necessary to analyse both the risks i.e. systematic and unsystematic risk. Whereas, systematic risk is the one which has major relation with the market. This kind of risk cannot be distributed or diversified. On contrary to this, unsystematic risk is related with the stock which can be diversified at the time of building portfolio. The stated tangible line depicts the premium risk that an individual can earn for taking extra risk. This line has major relation with CAPM model, as it is used in this model represents the rate of return of the effectual portfolios (Dayala, 2012).

Similarities and differences between the two models The major similarity between the models are that both the models focuses on the investment evaluation. Additionally, the major focus of the two models are on analysing the high rate of return of a risky asset. Besides this, the CAPM and CML model considers both the risk and return of the assets. At the time of building portfolio, it is necessary to consider both risk and return of an asset. This helps the investor to identify the major association of risk and return of an asset. However, the two methods are useful for the evaluation of risk effectively.

In context to above, there are certain differences carried by the two stated models. The CML focuses on the rate of return to an asset including the risky and risk free for the portfolio development. On another hand, SML is a graphical representation of the market risk of a particular period. It is seen that, both the models used in identifying the factors used to measure the risk. But the CML measures the associated risk of asset with the help of standard deviation (Dayala, 2012). But in case SML, the risk is measured with the consideration of beta. In addition to this, the CML line defines the portfolio consisting of expected return and security market line graphically shows the both the efficient and non-efficient portfolios. At the time of calculating the expected return the tangible line shows on the Y-axis of the graph. Whereas, SML explains the beta over the X-axis. In case of CML, the market portfolio and assets contains zero risk are explained by CML line. On contrary to this, the security factors determined by the SML line.

Among the two, CML line majorly considered at the time of risk measurement. This allows the investor to make appropriate risk decisions (Sekhar and Gudimetla, 2013).

CONCLUSION From the above report of managing financials it can be articulated that the above mentioned three tools such as capital budgeting, sensitivity analysis and scenario analysis are Avail the top class finance dissertation topics ideas from the Professional writers of Instant Assignment Help at affordable price.

very helpful for making effective business decisions. It can be said that sensitivity and capital budgeting both are related to each other where it shows probability and future value of potential investment respectively. Apart from this scenario as well as financial tools both are related in order to make better decisions for investment making. Further, it can be concluded that capital market line and capital asset pricing model both have some similarities and differences. Both the models are helpful in terms of assessing value of the portfolio where various investment avenues are available. Apart from this the CAPM helps to assessing overall portfolio value while CML is shows value of a particular security or investment avenue from more than two investment areas.

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REFERENCES Books and Journals Anghel, M. G. and Paschia, L., 2013. Using the CAPM Model to Estimate the Profitability of a Financial

Instrument

Portfolio.

Annales

Universitatis

Apulensis:

Series

Oeconomica.15(2). p.541.

Brown, P. and Walter, T., 2013. The CAPM: theoretical validity, empirical intractability and practical applications.Abacus. 49(S1). pp.44-50.

Coffie, W. and Chukwulobelu, O., 2012. The application of capital asset pricing model (CAPM) to individual securities on Ghana stock exchange. In Finance and Development in Africa (pp. 121-147). Emerald Group Publishing Limited.

Dayala, R., 2012. The Capital Asset Pricing Model: A Fundamental Critique. Business Valuation Review. 31(1). pp. 23-34.

Hsieh, H. H. and Hodnett, K., 2012. Cross-sector style analysis of global equities based on the Fama and French three-factor model. The International Business & Economics Research Journal (Online) .11(2). pp. 161.

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