Investment Decision Making Flashcards
Balance Sheet
Assets:
Fixed Assets:
- Intangible Assets
- Tangible Assets
- Financial Assets
Current Assets:
- Inventory
- Accounts Receivable
- Securities and Shares of Companies
- Cash and Cash Equivalents
Deferred Tax
Accruals
____________
Total Assets, Capital expenditures -> Allocation of funds
Liabilities (Capital):
Equity:
- Registered Capital (Share Capital)
- Capital Reserves
- Revenue Reserves
- Net Profit (Net Loss)
Debt
- Accruals
- Accounts Payable
Deferrals
____________
Total Liabilities (Total Capital), Financing -> source of funds
Payment Flow-Oriented Definition of Capital Expenditures
Capital expenditure marked by payment flow
starting with acquisition payout (e.g. machine is bought)
generating inpayment surplus (IPS) (e.g. revenue generated with machine)
possibly ending with liquidation surplus (LS) (e.g. machine is sold at end of useful time)
Assets-Oriented Definition of Capital Expenditures
involves transforming capital into assets
acquisitions of all assets in the narrower sense (fixed, current assets, know-how, information)
long-term usable means of production in the broader sense (resources)
Influence of Capital Expenditures on company performace
long-term capital tie-up
rigid cost structure
high data uncertainty
scarcity of funds
wrong decisions: strong influence on operating results
Categorization according to the occasions of Capital Expenditures
slides 2, page 5
https://ibb.co/4sJLhYX
Investing Process
1 Stimulation (internal, external, identification of opportunities)
2 Description (technical specification, cost estimation (financing, operating, acquisition), impact on profits)
3 Compilation of alternatives (leasing vs purchasing, make or buy)
4 Preselection (accordance to business objectives, consideration of limits, environmental sustainability)
5 realization (acquisition)
6 regulation (controlling to achieve objectives)
7 monitoring/verification: action control (deadlines, expenditures), results control (productivity, profitability)
Types of Investment Decisions
- singular investment decision (absolute investment decision)
- selection decision (relative investment decision)
- decision on useful life expectancy (optimal useful life expectancy)
- decision concerning the optimal point in time for replacement
- decision on the product line
Methods of Preinvestment Analysis
Preinvestment Analysis: make informed decision about investment opportunity
static: based on mean values, not taking into account the chonology of payments
dynamic: based on chash flows (multi period models), take into account chronology of payments (inpayments, payouts)
Methods of Preinvestment Analysis (Analytical Techniques)
Static Techniques:
* Cost Comparison Method
* Pay-off Method
* Average Return Method
* Profit Comparison Method
Dynamic techniques
* Present value techniques
* Net Present Value Method
* Internal Rate of Return Method
* Annuity Method
* Future Value Techniques
* Asset Future Value Method
* Method of Complete Financial Budgets
* Interest on Debt Method
Dynamic Preinvestment Analysis - points of criticism
problem of
uncertainty: hard to predict
attribution: hard determine which are responsible for generating inpayment surpluses
rate of return: hard to assess
decision problem: different dynamic methods can result in different results
Net Present Value (NPV)
value of the cash flows discounted to the beginning of the planning period
positive NPV indicates investment expected generate profit
overall performance of investment
NPV = (Cash Flow / (1 + r)^n) - Initial Investment
r…discount rate
Future Value (FV):
value of the cash flows compounded (accumulated) to the end of the planning period
expected value of an investment at a future point in time
FV = PV x (1 + r)^n
Discount Rate
required rate of return of the investor to invest
best possible alternative rate of return (opportunity cost)
higher discount rate -> higher level of risk
pure equity financing -> cost of equity
pure debt financing -> cost of debt
mixed equity and debt financing -> WACC (weighted average cost of capital)
Dynamic Preinvestment Analysis - Assumptions
known inpayment surpluses
assigning of all cash flows to end of the periods (as simplification)
certainty of all data (certainty of expectations)
possibility of reinvestment of inpayment surpluses
no relationship between investment opportunities
pefrect capital market
perfect capital market
no distinction between equity and debt
no limits of available capital
perfect market information (equal access to information for all and same expectations)
uniform capital market interest -> interest for debt and return on equity are the same
Net Present Value Method
whether an investment opportunity is able to pay-off the capital employed
difference in the net present value between inpayment surpluses and acquisition payout
abolute preferable: net present value is positive, pays off, RoR is achieved
relative preferable: comparatively to other opportunity, the one resulting in higher NPV
Annuity Method
periodical performance of the investment opportunity
NPV_0 * i / (1-(1+i)^-n)
annuity = regular payment that an investor can use without risking their initial investment or required rate of return
Evaluation of preferability:
absolute preferable = annuity is positive
relative preferable = investment opportunity achieving the higher annuity
Internal Rate of Return Method
relative performance (internal rate of return) of the investment opportunity
internal rate of return: RoR resulting in NPV of zero, actual RoR of capital employed
if IRR is greater than required rate of return -> investment profitable
can result in a discrepancy between the results of the net present value (NPV) method because it involves cutting NPV function
Asset Future Value Method
assess the increase in financial assets effectuated by an investment opportunity at the end of the investment period (planning period)
Assumes two rates: interest on debt (s) and interest earned (h)
‘s’ is cost of raising unlimited capital
‘h’ is rate from unlimited capital investment
Absolute preference: asset future value > 0
Relative preference: Highest future value among options
Uses two methods: Prohibition of Settlement of Accounts and Commandment of Settlement of Accounts
Asset Future Value Method - Prohibition of Settlement of Accounts
Uses two separate accounts: assets and liabilities
Assets absorb positive income surpluses, compounded to end of period using interest rate earned (h)
Liabilities absorb negative income surpluses, compounded using interes rate on debt
Settlement occurs only at end of investment period (planning period)
Commandment of Settlement of Accounts
Asset Future Value Method
Uses one collective account
Account absorbs both positive and negative income surpluses
Settlement occurs immediately at end of each period
If account balance is positive, interest is credited using interest rate earned (h)
If account balance is negative, interest is debited using interest rate on debt (s)
Interest on Debt Method
Calculates critical interest rate on debt (s_k)
s_k leads to Asset Future Value of zero
Interest rate on debt (s): cost of unlimited capital raising
Interest rate earned (h): rate from unlimited capital investment
Absolute advantage: s_k > s
Relative advantage: Investment with higher s_k, given s_k > s
Method of Complete Financial Budgets
Tabulates all cash flows assignable to investment
Includes exact presentation of financing cash flow
Decision Making Factors
* Proportion of debt and equity financing
* Extent of liability amortization using inpayment surpluses
* Extent of payouts financed by disposable assets
* Diversity in credit terms
Absolute preferable: Asset Future Value > 0
Relative preferable: Investment with higher asset future value, given asset future value > 0
