02 investment decision

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02 investment decision

  1. 1. WEEK 3 INVESTMENT DECISIONS Module: BLB20059-M MANAGING RISK
  2. 2. OUTLINE • Capital investments: Importance and difficulties • Types of capital investments • Phases of capital budgeting • Levels of decision making • Facets of project analysis • Feasibility study: A schematic diagram • Objectives of capital budgeting • Common weaknesses in capital budgeting Project Management by Prasana Chandra © Centre for Financial Management, Bangalore
  3. 3. CAPITAL INVESTMENTS : IMPORTANCE AND DIFFICULTIES Importance • Long – term effects • Irreversibility • Substantial outlays Difficulties • Measurement problems • Uncertainty • Temporal spread Project Management by Prasana Chandra © Centre for Financial Management, Bangalore
  4. 4. TYPES OF INVESTMENTS •Mandatory Investments •Replacement investments •Expansion investments •Diversification investments •R & D investments •Miscellaneous investments Project Management by Prasana Chandra © Centre for Financial Management, Bangalore
  5. 5. CAPITAL BUDGETING PROCESS Planning Analysis Selection Financing Implementation Review Project Management by Prasana Chandra © Centre for Financial Management, Bangalore
  6. 6. LEVELS OF DECISION MAKING Operating Administrative decisions decisions Lower level Middle level management management management • How structured is the decision Routine Semi – structured Unstructured • What is the level of resource Minor resource Moderate resource Major resource commitment commitment commitment commitment What is the time horizon Short – term Medium – term Long – term • Where is the decision taken • Strategic decisions Top level Project Management by Prasana Chandra © Centre for Financial Management, Bangalore
  7. 7. KEY ISSUES IN PROJECT ANALYSIS Potential Market Market Analysis Market Share Technical Viability Technical Analysis Sensible Choices Risk Financial Analysis Economic Analysis Return Benefits and Costs in Shadow Prices Other Impacts Environmental Damage Ecological Analysis © Centre for Financial Management, Bangalore Restoration Measures
  8. 8. FEASIBILITY STUDY : A SCHEMATIC DIAGRAM Generation of Ideas P r e Initial Screening l i m Is the Idea Prima Facie Promising i No Yes n a Plan Feasibility Analysis r Terminate y W o Conduct Market Analysis Conduct Technical Analysis r k A n a l y s i s E Conduct Financial Analysis v a Conduct Economic and Ecological Analysis l u a Is the Project Worthwhile ? Yes t i o Prepare Funding Proposal n © Centre for Financial Management, Bangalore No Terminate
  9. 9. OBJECTIVE OF CAPITAL BUDGETING Finance theory rests on the premise that managers should manage their firm’s resources with the objective of enhancing the firm’s market value. This goal has been eloquently defended by distinguished finance scholars, economists, and practitioners. Wit the following : “The quest for value drives scarce resources to their most productive uses and their most efficient users. The more effectively resources are deployed, the more robust will be economic growth and the rate of improvement in our standard of living.” © Centre for Financial Management, Bangalore
  10. 10. BASIC CONSIDERATIONS: RISK AND RETURN Investment decisions Return Market value of the firm Financing decisions Risk © Centre for Financial Management, Bangalore
  11. 11. COMMON WEAKNESSES IN CAPITAL BUDGETING •Poor alignment between strategy and capital budgeting • Deficiencies in analytical techniques • Poor identification of base case • Inadequate treatment of risk • Improper evaluation of options • Lack of uniformity in assumptions • Neglect of side effects • No linkage between compensation and financial measures • Reverse financial engineering • Weak integration between capital budgeting and expense budgeting • Inadequate post - audits © Centre for Financial Management, Bangalore
  12. 12. Summing Up • Essentially a capital project represents a scheme for investing resources that can be analysed and appraised reasonably independently • The basic characteristic of a capital project is that it typically involves a current outlay (or current and future outlays ) of funds in the expectation of a stream of benefits extending far into the future • Capital expenditure decisions often represent the most important decisions taken by a firm. Their importance stems from three inter-related reasons: long-term effects, irreversibility, and substantial outlays • While capital expenditure decisions are extremely important, they pose difficulties which stem from three principal sources: measurement problems, uncertainty, and temporal spread • Capital budgeting is a complex process which may be divided into six broad phases: planning, analysis, selection, financing, implementation and © reviewCentre for Financial Management, Bangalore
  13. 13. • One can look at capital budgeting decisions at three levels: operating, administrative, and strategic • The important facets of project analysis are : market analysis, technical analysis, financial analysis, economic analysis, and ecological analysis • Financial theory, in general, rests on the premise that the goal of financial management should be to maximise the present wealth of the firm’s equity shareholders. Business firms may pursue other goals. When these other goals conflict with the goal of maximising the wealth of equity shareholders, the trade – off has to be understood • The common weaknesses found in capital budgeting systems in practice are: poor alignment between strategy and capital budgeting ; deficiencies in analytical techniques; no linkage between compensation and financial measures; reverse financial engineering; weak integration between capital budgeting and expense budgeting ; inadequate post-audits. © Centre for Financial Management, Bangalore

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