Dec 22 2007
Business Investment Decision
Investment policies have given a new perspective to the role of financial administration, this has made the topic is of interest to all scholars and lovers of finance
Investment decisions are a major financial decisions, all decisions relating to business investment from the analysis of investment in working capital such as cash, banks, accounts receivable, inventory and investment capital represented in fixed assets such as buildings, land, machinery, technology etc.
To make the right decisions the financier has to take into account elements of assessment and analysis as the criteria for analysis, cash flows associated with investment, the investment risk and rate of return required.
Generally
A greater risk, greater use
Definition of criteria for analysis in investment
In most types of organizations or private companies, financial decisions are focused or have a clear objective, “the maximization of assets by the utilities, this fact in the present conditions, must refocus on a” maximizing wealth and the creation of “business value”.
Against this background in investment resources are allocated and results obtained from them, the costs and benefits.
The criteria for making an investment analysis of treatment benefits and costs of an investment proposal, these benefits and costs in most cases do not occur instantly, but that can be generated for varying periods.
When you find the costs and benefits must be clearly defined criteria to be used for evaluation against the investment proposal.
Among the criteria that have achieved a high degree of technical acceptance by the financiers, who consider the value of money over time, making treatment of the discounted flows of costs and benefits. Can be mentioned among them the net present value, the rate of return, the benefit / cost and the Internal Rate of Return, which provides the information necessary for investment analysis.
Cash flows associated with investment
When making an investment the company expects a number of expenses and production costs for a certain number of future benefits, these generation costs and profit is called “Cash Flow”, whose components are:
1. Amount and timing of investment
This expresses the amount of initial investment is made in cash disbursements or credits and their use against fixed assets or working capital.
Must also take into account the various additional investments during the life of the project as a result of replacing equipment, purchasing new technology, increased working capital, to get a rough estimate of these disbursements.
2. Amount and timing of returns
This is reflected in how much and how long it expects to receive the income generated from investment by the company.
In the same way should provide resources for investment, it is necessary to establish that time and that amount shall be the recovery of investments.
Most investors shun risk, as they seek to maximize their wealth with the least possible risk
The “Cash Flow”, by taking the value of money over time, provides a substantial base on cash after taxes.
The analysis was performed on an incremental basis, that governs both investment costs and hence the income they derive.
A very important aspect in the analysis of flows, is given by the direct relationship that this new project may have with others that are already underway within the company, ie a project tends to affect the flow of funds from other investments Such effects should be incorporated into the computation of the new flow of funds so as not to disturb the normal functioning of other investments.
Risk of investing
The future is uncertain, everything that happens around us may change from time to time, therefore to make an investment decision must take into account the risk factor.
The risk of an investment is measured by the variability of possible returns around the average or expected of them, ie, the risk is given by the deviation of the probability function of potential returns.
Every investment has two components of risk, one that depends on the very investment that is related to the company and the type of sector in which it invests, this is called diversifiable risk and another that is set by the market in general and affects All investments in the market and is known as non-diversifiable risk.
In making decisions on investments are minimized if the risk is an efficient diversification of risk and not a proper measurement of diversifiable. The measure of non-diversifiable risk is given by Beta (B), which links the returns of the market with an investment in particular.
An investment with Beta greater than 1 means that a 1% increase in returns of the market, increases in asset returns in greater proportion and if the Beta is less than 1, the opposite happens.
The contribution that a new investment can make to an efficiently diversified portfolio, dependent on the Beta which has, since the risk is greater the higher the beta of the assets that compose it.
Rate of return required for investment
The required rate of return is the minimum rate of return that is required for an investment that will be accepted. In determining this rate must take into account all internal and external factors that influence the investment decision.
The assumption in financial theory which states that “investors are risk-aversive” takes great significance in the sense that, as there is more risk involved in the decision to invest in a project will require a higher yield resources invested.
Thus, the expected return for an investment project depends on the specific project risk assessment, taking into account the risk free rate and reditualidad to invest in this project.
The aspects discussed above are an effective tool in achieving the proper financial management in the decision to rent business investment, but all this must be substantiated and supplemented by technical studies, math and controls implemented by the monitoring responsible for the financial area of the company.
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