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Transcript of Investment Analysis
Javier Rodriguez Content: Investment and its role in a
Corporate Finance Environment
Traditional Investment Appraisal
Strategic Investment Analysis
Work Shop The role of Corporate Finance Important terms Capital Investment Process
Search for and development of projects : preliminary screening, project definition, project classification
Evaluation and authorization of project: evaluation, authorization, monitoring & control
Post-auditing source:Richard, P. 2009. Corporate finance and investment : decisions & strategies, Harlow, England, Harlow, England : Prentice Hall Financial Times. "INVEST" - the commitment of money or capital to purchase financial instruments or other assets in order to gain profitable returns in the form of interest, income, or appreciation of the value of the instrument."
(Sullivan and Sheffrin, 2005 )
Real and Finance Investment Traditional Financial Investment
Appraisal Methods Adoption by U.K. Industry Risk analysis With any kind of investment there is an associated risk
Risk is related to uncertainty
Risk analysis is not aimed to remove risk but to better identify and understand it
Many methods can be deployed to identify the risks we are undertaking in our investment, some of them are resource consuming Popular Risk Analysis methods Scenario analysis
Risk adjusted rate on return
Shorten Payback period
Beta Analysis Accounting rate of return (ARR)
Payback Period (PB)
Net present value (NPV)
Internal rate of returns (IRR) Discounted Cash flow Techniques (DCM) Use cash flows to determine value of investment
NPV and IRR consider the time value of money F.Alkaraan, D.Northcott / the British Accounting Review 38 highly adopted Pizza Oven Investment Accounting rate of return (ARR)
Total Cash flows: $30.000
ARR = $10.000 / $20.000 = 50%
Payback Period (PB)
Annual Cash flow: $5.000 /year
Payback Period: $20.000/$5.000 = 4 years bias towards short term, less strategic investments
determination of input variables can be inaccurate
decision becomes less rational
intangible non-quantifiable project attributes not captured Pitfalls Beta Analysis Shorten Payback period Strategic investment decision making Strategic factors Links to finance Consistent with corporate strategy
Requirements of customers are
incorporated The company must keep up with
competitors The quality and reliability of outputs Company must maintain ability to
expand in the future Increased returns
Customer will not buy
the product if low quality
or competitor has better
Expansion will help
increase returns Approaches to Integrate
Finance and Strategic Benchmarking: Identifies best practice in industry & promotes competitive awareness Balanced scorecard: Could link financial performance to strategic performance
Value chain: Finds value creating activities so competitive strategies can be developed Tech Road mapping: Highlights roles between tech and products. Helps put resources in right place for product development
Difficult to apply due to lack of data
Academic exercises rather than practical tools
People don’t understand what model means
Black box approach can cause more trouble than good
Intuition, experience and judgement are what is needed. You can’t use academic tool and say that it makes sense without knowing company
Why financial managers don’t use these approaches?
Risk adjusted rate on return Work Shop A company is having a discussion into which project invest base on the investment analysis tool results:
Conclusion Which is the best method ?
How to decide which to use? „We believe it [NPV] to be the most rigorous evaluation of the project ability to add value to shareholders.“
(Group Finance Director) „Strategic investment projects should not be justified solely on their capacity to create economic value for the firm“
F. Alkaraan, D. Northcott „If you want to prepare to make an investment by collecting all the information you want and being 100% happy with the integrity of that information, you might considerably minimise the risk, but it‘s likely that you‘ll miss the opportunity because you spend so much time gathering the information“
(Group Finance Director)
„An important role clearly remains for the ‘art‘ of judgement by the decission-maker“ F. Alkaaran, D. Northcon
All methods can only support the
investment decision making !
Thank you !
Sometimes we have to make investments due to environmental considerations, which is important to preserve the business and to maintain credibility and reputation…We‘ll do those projects even if they do not have a financial return“
(Group Finance Director)
„I would never say I would only do something because the numbers make sense. But equally, I‘d never say I would only do something because it is strategic.“ (Group Finance Director)