5016 - Investment and Financial Analysis - The Criteria for Investment Decisions p61-85 Flashcards
Considerations in Investment Selection
Security Liquidity Return Growth Prospects Spreading Risk
Factors influencing investment decisions
- Availability of Funds
- Amount Required
- Cashflow projections
- Investment Opportunities
- Existing Investments
- Strategic Issues
- Attitude towards risk and/or need to reduce risk
- Transaction Costs & Insurance/Maintenance Costs
- Market Expectations/Influences on price change
- Ethics
Factor 1: Availability of Funds
How much do you have
Factor 2: Amount Required
How much money do you need, some investments require a minimum sum
Factor 3: Cashflow projections
Influences your need for liquidity and your ability to invest long term
Factor 4: Investment opportunities
Do you have the chance to invest in projects with a net present value
Do you have access to capital and money markets
Factor 5: Existing investments
You may want more of the same or wish to diversify to spread or reduce risk
Factor 6: Strategic Issues
Companies may buy a controlling interest or merge/takeover a
company for manufacturing benefits/synergies and economies of
scale, not simply as a financial investment
Individuals may invest in the share of certain companies for personal reasons/interest
Factor 7: Attitude towards risk or need to reduce risk/
Companies and individuals are risk averse and therefore seek to hedge and reduce risk whilst others may speculate. For some the risk may be too high e.g. a car company speculating the price of steel will go up so they buy loads and then the price decreases
Factor 8: Transaction Costs and Insurance/Maintenance costs
High transaction costs need to be recovered in order to make a profit
Factor 9: Market Expectations and influences on price changes
Inflation Interest Rates Exchange Rates Oil Prices And more
Factor 10: Ethics
You may not invest in certain things due to your ethics, or may not be allowed due to your companies ethics for example Lush or any environmentally conscious business wouldn’t start investing in offshore oil
The Capital Investment Process
Search - Identify opportunities
Screening - Ethics, Strategic fit and payback
Definition - Collection of more detailed info about projects
Evaluation - Financial - Use of formalised selection criteria e.g. payback, ARR, NPV, IRR
Approval
Financial Management
“The management of all the processes associated with
the efficient acquisition and deployment of both short-
term and long-term financial resources involving financial
planning and financial control with the objective of
maximising shareholders wealth”
CAPEX meaning
Capital Expenditure - Funds used by a company to acquire, upgrade and maintain assets
Capital Investment Appraisal
i.e. deciding what projects to undertake and invest money in
Managing projects
This involves budgeting, costing and cash management
Assessment of Projects
Looking at profitability via the income statement
Servicing Finance
Things like paying interest and deciding whether to pay dividends or re-invest, this is called the Dividend Decision
What is Capital Investment
The expenditure of money to fund a company’s long term growth
Weighted Average Cost of Capital
Represents a firms average cost of capital from all sources
WACC Formula
WACC = [(Weightage of equity X Cost of Equity) + (Weightage of Debt X Cost of
Debt)] x (1 - Tax Rate)
The Investment Process
Step 1: Obtain Funds
Step 2: Evaluate available investment opportunities and make a selection
Step 3: Structure the terms of the investment
Step 4: Implement the deal and monitor progress
Step 5: Achieve returns and exit from the investment
The Financial Evaluation Process
Step 1: Establish a Hurdle Rate
Step 2: Analyse Cash Flow and Risks
Step 3: Select an Evaluation Technique
Step 4: Evaluate the Projects
Step 5: Rank the Projects
