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Principles Of Finance Assignment

Introduction-Principles Of Finance

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Competing theories of capital structure

Different sources of capital

Sources of capital refer to the undistributed profits and savings of the owner of the company that can be used in future to mitigate the dues or for further acquisitions. As opined by Loorbach et al. (2020), there different sources of capital that are used in a firm are bonds, federal funds, credit capital, financial bootstrapping, venture capital, angel investors, equity finance, debt, and foundation grants. These sources generate funds to manage the acquisition and debts of the firm to enhance the profit segments. As per the view of Brealey et al. (2018), the capital is mainly invested in the ongoing production element where the company is engaged in gaining profit. The investment process and the capital markets usually retain the funds for meeting the uncertainties in near future.

Figure 1: sources of finance

(Source: self-created)

Capital structure

The capital structure of the firm shows the mixture of equity finance and debt of the firm that is used to finance the firm's assets and its operations. As stated by nZutter and Smart (2019), in the context of a corporate perspective, equity is the permanent source of raising funds and its expensive nature makes the capital structure more efficient. These financial operations enable the growth and expansion of the firm. For example- 40% common stock, 50% preferred stock and 60% long-term borrowings might reflect the capital structure of the firm. As per the author Nielsen and Kristensen (2020), it is basically written on the right side of the balance sheet. It has two types: debt and equity and the other funds that are raised from the shares, retained earnings, preference shares and long-term loans.

The weighted average cost of capital (WACC)

WACC shows the average cost of capital of the firm from all the sources of finance including common and preferred stock and other types of debts. As per the view of Yescombe and Farquharson (2018), it is calculated by using the formula “(E/V * Ke) + (D/V) * Kd * (1 – Tax rate)”. It is an important financial metric which is used in wide financial circles. However, it is used to test whether the investment returns can exceed the limit or can meet the value of the assets or the project. It is noted that the lower WACC implies higher returns from the market. As mentioned by Ballandies et al. (2021), investment opportunities are also evaluated through WACC as it shows the opportunity costs of the firm. WACC is considered to be good when it meets the line with average segments.

Comparison of different theories

There are various theories that are used in the competing capital structure that helps in raising the funds for the company in a short period of time. As stated by Peiris et al. (2021), the theories such as “trade-off, agency theory, contracting cost and information costs theories, Modigliani and Miller Theory (MMT), and Pecking Order Theory”. The financial leverage of the firm is measured by using different models and theories. For example- in MMT theory the capital structure of the firm is stated as irrelevant whereas in pecking theory it is stated that the financial mix is stated as the relevant element to evaluate the company's capital structure (Ross and Wright 2021). Therefore different theories have different aspects to measuring the financial leverage and all the above-mentioned theories are accurate to be adopted in any kind of firm.

Finance professionals mainly use the MMT model, pecking order theory and trade-off theory in stating the capital structure of the firm. As per the view of Hall et al. (2018), this is because the propositions and their elements imply accurate risks in the evaluation of the firm financial and managerial decisions regarding the business. In contrast to this pecking, theory assimilates the asymmetrical information of the financial costs of the firm. This approach shows that the lower resistance of the firm is obtained through the external equity calculations (Mitchell et al. 2021). The theories are also applicable in ascertaining the best investment appraisal for the firm as it implies the accurate time period of getting the returns or outcomes.

Capital structure has changed over the last three years

In order to ascertain the capital structure of the firm Aviva plc has been chosen. The financial statements are used to evaluate the WACC and financial position of the firm. As mentioned by Kersen et al. (2022), Aviva plc is an insurance company operating in the country of the UK. It was founded in the year 2000, in London, United Kingdom. The Revenue of the firm is evaluated at around 3,318.4 crores GBP in the year 2021. The ordinary shares of the firm are valued at 33.25% and the “cumulative irredeemable preference shares of £1 each”. The last three years' capital structure of the firm is valued at 18.0 where the face value of shares is valued at 10.0 and the no. of shares that are issued by the company is 1499000. From the above-mentioned data, it can be seen that there are no frequent changes in the firm capital in the last three years.

The level of debt

The debt of Aviva plc in the last three years is valued at 8,423, 11,125, and 10,481 in 2019, 2020 and 2021. As per the view of Oduro et al. (2019), these values include the ST Debt and Current Portion of the company, and long-term debts. The percentage growth in the debt value is ascertained as -24.29%, 6.14%, and -2.17% in the last three years. From the percentages, it can be seen that the firm is getting a negative value of debt. These negative values show that the firm does not have an accurate level of liquidity from which it can pay off its debts (wsj.com, 2022). However, the firm has a negative debt value it seems that the firm is running in a good position.

The bonds of the company were valued at 113,449, 185,827, and 184, 29 for the three years. The loans and the LT debts are valued at 7,695, 9,915, and 9,611, it can be stated that the firm has fewer loans in comparison with other firms which operate in the same niche.

The level of equity

The equity level of the company Aviva plc shows the average position of the equities from the stated financial reports. The value shareholder's equity in the last three years was valued at 19,202, 19,554 and 17,708 (aviva.com, 2022). It can be stated that in the year 2021 the share value was reduced by a few percentages but in the year 2020, it can be seen that the values of the shares were increased from 17708 to 19554. The dividend of the company increased by “31p per share in the year 2022”. It shows a 7.1% yield in the original value of shares.

Figure 2: Level of debt and equity of Aviva plc

(Source: statista.com, 2022)

From the above graph it can be seen that the insurance levels of the firm in terms of life and general insurance. In the year 2021, the general insurances show 4.7 billion income in British pounds through which equity level has grown by 5.65 in the same year. In the context of debt, it can be stated that the company has enough liquidity to cover its obligations and dues.

Figured for capital and income gearing

Capital gearing refers to the ratios of debt levels to the equity of the company. From the above-mentioned data on debt and equity, it can be stated that the negative debt levels of the firm represent the company's better position in the competitive market. As per the author Brigham et al. (2022), therefore the equity level of the firm is more rather than its debts. However both the positions show accurate balances. Therefore the capital gearing of the firm is stated between the levels (25-50%). The level of debt and equity shows the gearing ratio which also shows the financial leverage of the firm to get accurate results from the top insurance companies.

WACC calculations

Calculation of WACC of Aviva PLC

Capital fund

Market value

Cost of capital















Table 1: calculation of WACC

(Source: self-created)

From the above table it can be stated that the WCC of reform is obtained at 2.42% by using the debt and equity value. As narrated by Greenwood and Warren (2022), the values are showing less preference for the ideal or standard value. The higher WACC implies higher returns in the capital whereas lower values imply losses in near future. Therefore the firm needs to reevaluate the WACC and the equity value to get proper returns at an average level. The cost of capital of the country UK is assumed at 2.75% for equity and 1.65% for debt. The Total value of sources of finance is summed up to 27877; from this the cost of capital is multiplied to get accurate results.


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