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INVESTMENT DECISIONS Module: BLB20059-M MANAGING RISK
Overview of Management Project Management by Prasana Chandra © Centre for Financial Management, Bangalore 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 OUTLINE
Overview of Management 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
Overview of Management Mandatory Investments Replacement investments Expansion investments Diversification investments R & D investments Miscellaneous investments Project Management by Prasana Chandra © Centre for Financial Management, Bangalore TYPES OF INVESTMENTS
Overview of Management CAPITAL BUDGETING PROCESS Financing Implementation Selection Analysis Review Planning Project Management by Prasana Chandra © Centre for Financial Management, Bangalore
Overview of Management Operating Administrative Strategic decisions decisions decisions Where is the decision taken Lower level Middle level Top 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 Project Management by Prasana Chandra © Centre for Financial Management, Bangalore LEVELS OF DECISION MAKING
Overview of Management © Centre for Financial Management, Bangalore KEY ISSUES IN PROJECT ANALYSIS Market Analysis Potential Market Market Share Technical Analysis Technical Viability Sensible Choices Financial Analysis Risk Return Economic Analysis Benefits and Costs in Shadow Prices Other Impacts Ecological Analysis Environmental Damage Restoration Measures
Overview of Management © Centre for Financial Management, Bangalore FEASIBILITY STUDY : A SCHEMATIC DIAGRAM Generation of Ideas Initial Screening Is the Idea Prima Facie Promising Plan Feasibility Analysis Conduct Market AnalysisConduct Technical Analysis Conduct Financial Analysis Conduct Economic and Ecological Analysis Is the Project Worthwhile ? Prepare Funding Proposal Terminate Yes No Yes PreliminaryWorkAnalysisPreliminaryWorkAnalysis EvaluationEvaluation
Overview of Management © Centre for Financial Management, Bangalore 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.” OBJECTIVE OF CAPITAL BUDGETING
Overview of Management © Centre for Financial Management, Bangalore BASIC CONSIDERATIONS: RISK AND RETURN Investment decisions Financing decisions Return Risk Market value of the firm
Overview of Management © Centre for Financial Management, Bangalore 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 COMMON WEAKNESSES IN CAPITAL BUDGETING
Overview of Management © Centre for Financial Management, Bangalore 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 review
Overview of Management © Centre for Financial Management, Bangalore 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.
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