Investment appraisal Flashcards
Predictive analytics
Linear regression
Decision trees - identify the impact of different decisions on the outcome of an investment - can consider multiple options and the impact of real options : most likely, best, worst etc
Simulation ie Monte Carlo - allows the effect of >1 variable changing - 100/1000s stimulations are ran to record the NPVs for different combinations = results show distribution of expected NPVs
Prescriptive analytics
Combine predictive analytics with AI and algorithms -> calculate the optimum outcome
Used for: capital rationing decisions, replacement analysis
BUT: complex, requires specialist data scientists, reliability of model depends on reliability of data used
Statistics
Mean
Standard deviation - spread of variation
Coefficient of variation - sd/mean = spread of variation in relation to the mean - can compare as is standardised (no units)
Valuation models other than CAPM : Farma and French
Farma and French = 3 factors
1. Sensitivity to market risk (like CAPM)
2. Size = difference in return between small and large capitalisation
3. Value = the difference in return between high NBV and low NBV
(4. Momentum = a share which has been increasing in price will continue to do so)
Valuation models other than CAPM : Fundamental Beta
CAPM beta = uses historical data
Fundamental beta = adjusting beta to account for nature of business operations, level of operational gearing (fixed costs), kevel of financial gearing (D vs E)
Valuation models other than CAPM : Arbitrage Pricing Theory
Like CAPM but with LOTS OF SYSTEMATIC FACTORS (capm = only beta)
it is a multi-factor asset pricing model
Valuation models other than CAPM : Bond-yield approach
the return on equity for a company is typically HIGHER than the yield on bonds in a company
therefore:
if this equity market premium was constant and observable = the required rate of return for equity could be calculated by adding this fixed premium onto the appropriate bond yields
Valuation models other than CAPM
- Farma and French - 3 factor model (value, momentum, market risk, size)
- Fundamental beta - adjusting CAPM’s beta to account for the risk caused by the NATURE of the business operations, the OPERATIONAL GEARING (fixed costs) + FINANCIAL GEARING (debt vs equity)
- Arbitrage pricing model - like CAPM but with lots of systematic risk factors (not just beta)
- Bond-yield model - return on equity > yield on bonds: if know the premium for equity, can simply add onto the yield for bonds
Political risks
= the risk that political action will affect the position and value of a company
-quoatas/tarrifs/barriers imposed by the overseas government
-nationalisation of assets by the overseas government
-stability of the overseas government
-political and business risks
-economic stability/inflation
-remittance restrictions
-special taxes
-regulations on overseas investors
Systematic risk vs non-systematic risk
Both = BUSINESS RISK (variability in PBIT)
Non-systematic risk - specific risk due to industry, company etc
ie. chairman resigning, strikes by employees of the company, changes in regulations which affects a particular market sector
Can be reduced by diversification (portfolio theory)
Systematic risk - all companies are exposed to no matter which market sector; risk due to macro-economic factors
ie interest rate changes, economic recession, oil price changes, wars
Cannot be diversified away
Financial risk
Variability in PAT
Additional exposure to systematic risk due to financial gearing + associated interest payments
Interest = additional fixed costs even in profits low - can go from profits->losses
Causes beta eq > beta asset
Accounting rate of return
PAT/opening shareholder funds
or
average annual profit/average shareholder funds
Profitability index
=profitability/capital required (NPV/initial capital)
Used for capital rationing - invest in projects with a high PI
Hard capital rationing vs soft capital rationing
Hard = there are no funds - externally imposed limit
Soft = there are limited funds - internally imposed limit on investment - need to invest in high PI projects
Non financial factors to consider when appraising new projects:
-compliance of the project with current / future legislation
-impact of the project on staff morale
-impact on suppliers and customers
-impact on the organisation’s reputation
-sustainability of resources used in the project
