5016 - Investment and Financial Analysis - The Criteria for Investment Decisions p61-85

Question 1

Considerations in Investment Selection

Answer 1

Security
Liquidity
Return
Growth Prospects
Spreading Risk

Question 2

Factors influencing investment decisions

Answer 2

• 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

Question 3

Factor 1: Availability of Funds

Answer 3

How much do you have

Question 4

Factor 2: Amount Required

Answer 4

How much money do you need, some investments require a minimum sum

Question 5

Factor 3: Cashflow projections

Answer 5

Influences your need for liquidity and your ability to invest long term

Question 6

Factor 4: Investment opportunities

Answer 6

Do you have the chance to invest in projects with a net present value

Do you have access to capital and money markets

Question 7

Factor 5: Existing investments

Answer 7

You may want more of the same or wish to diversify to spread or reduce risk

Question 8

Factor 6: Strategic Issues

Answer 8

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

Question 9

Factor 7: Attitude towards risk or need to reduce risk/

Answer 9

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

Question 10

Factor 8: Transaction Costs and Insurance/Maintenance costs

Answer 10

High transaction costs need to be recovered in order to make a profit

Question 11

Factor 9: Market Expectations and influences on price changes

Answer 11

Inflation
Interest Rates
Exchange Rates
Oil Prices
And more

Question 12

Factor 10: Ethics

Answer 12

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

Question 13

The Capital Investment Process

Answer 13

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

Question 14

Financial Management

Answer 14

“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”

Question 15

CAPEX meaning

Answer 15

Capital Expenditure - Funds used by a company to acquire, upgrade and maintain assets

Question 16

Capital Investment Appraisal

Answer 16

i.e. deciding what projects to undertake and invest money in

Question 17

Managing projects

Answer 17

This involves budgeting, costing and cash management

Question 18

Assessment of Projects

Answer 18

Looking at profitability via the income statement

Question 19

Servicing Finance

Answer 19

Things like paying interest and deciding whether to pay dividends or re-invest, this is called the Dividend Decision

Question 20

What is Capital Investment

Answer 20

The expenditure of money to fund a company’s long term growth

Question 21

Weighted Average Cost of Capital

Answer 21

Represents a firms average cost of capital from all sources

Question 22

WACC Formula

Answer 22

WACC = [(Weightage of equity X Cost of Equity) + (Weightage of Debt X Cost of
Debt)] x (1 - Tax Rate)

Question 23

The Investment Process

Answer 23

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

Question 24

The Financial Evaluation Process

Answer 24

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

Question 25

Hurdle Rate

Answer 25

Minimum Rate of return on a project or investment required by a manager or investor

Question 26

Traditional Methods of Investment Appraisal

Answer 26

Accounting Rate of Return

Payback

Question 27

Discounted Cash Flow Methods of Investment Appraisal

Answer 27

Net Present Value

Internal Rate of Return

Question 28

Four Methods of Investment Evaluation

Answer 28

• Accounting Rate of Return (ARR)
• Payback Period (PP)
• Net Present Value (NPV)
• Internal Rate of Return (IRR)