Investment Appraisal Notes
Investment appraisal: Investment appraisal is an integral part of capital budgeting (see capital budget)., and is applicable to areas even where the returns may not be easily quantifiable such as personnel, marketing, and training
Inflation: Inflation is the rate at which the general level of prices for goods and services is rises and subsequently, purchasing power falls.
Types Of inflation:
- Demand pull inflation
- Cost push inflation
- Built-in inflation
Risk analysis: Risk analysis is the process of defining and analyzing the dangers to individuals, businesses and government agencies posed by potential natural and human-caused adverse events.
Risk: The quantifiable likelihood of loss or less-than-expected returns. Examples: currency risk, inflation risk, principal risk, country risk, economic risk, mortgage risk, liquidity risk, market risk, opportunity risk, income risk, interest rate risk, prepayment risk, credit risk, unsystematic risk, call risk, business risk, counterparty risk, purchasing- power risk, event risk.
Systematic risk: Systematic risks are associated with external environment , these are non diversifiable and is associated with securities market as well as economic, sociological, political considerations of the prices of all securities in the market. Unsystematic risk: Unsystematic risk is also called unique risk and it is unique to firm or industry. It is caused by factors like labour strike, irregular disorganised management policies and consumer preferences.
Business risk: This relates to the variability of the business, sales, income, profits etc. which in turn depend on the market conditions for the product mix, input supplies, strength of competitors, etc. The Internal Business Risk leads to fall in revenues and in profit of the company, but can be corrected by certain changes in the company’s policies.
Financial risk: This relates to the method of financing, adopted by the company, high leverage leading to larger debt servicing problems or short-term liquidity or process equipment, as well as utilities, support and related assets. It should not be based on the insured value or depreciated value of the assets. It includes the replacement value of the buildings and the grounds if these assets are maintainted by the maintenance expenditures.
Replacement decision: Decision regarding replacement of an existing asset with another is based on the net present value and internal rate of return of the incremental cash flows, i.e. the difference between periodic net cash flows if the existing asset is kept and the periodic net cash flows if the asset is replaced. In Capital budgeting and enqineering economics, the existing asset is called the defender and the asset which is proposed to replace the defender is called the challenger. Estimation of incremental cash flows for such replacement analysis involves calculation of net cash flows of the defender, net cash flows of the challenger and then finding the difference in cash flows for both the assets.
Capital rationing: Capital rationing is the act of placing restrictions on the amount of new investments or projects undertaken by a company. This is accomplished by imposing a higher cost of capital for investment consideration or by setting a ceiling on specific portions of a budget.
Various capital investment appraisal techniques:
- Net present value.
- Accounting rate of return.
- Internal rate of return.
- Modified internal rate of return.
- Adjusted present value.
- Profitability index.
- Equivalent annuity.
- Pay back period.
Various types of Capital rationing:
- Soft Rationing.
- Hard Rationing.
Different tax system of international risk management:
- Establishing the context.
- Identification.
- Assessment.
- Potential risk treatments.
- Risk avoidance.
- Risk reduction.
- Risk retention.
- Risk transfer.