The conception of this work aims in a tight synthesis to collect the aspects that in our consideration are essential about what investment refers to. Starting by defining investment as the act of sacrificing benefits to obtain others, this should be considered, as well as the management to finance, the main decision that a financial director will undertake as the brain of the company before the variables imposed by both the internal and external environment. Given the importance of knowledge of situations that condition an unexpected result when executing the investment, the document has collected some inconvenient factors to illustrate the feasibility of one or another project to consider.Four criteria are discussed in this material to classify according to the expectations and needs of the investing company. In addition, the tools or instruments to turn to are taken to your consideration to define whether or not to accept, for example, the construction of a building, the purchase of land or the acquisition of certain technology. Of all these tools, the Net Present Value (NPV) is the most efficient to accept the investment because it considers it more important to have a dollar today than tomorrow by generating returns early. Here are some examples to help you understand how it is calculated.the purchase of land or the acquisition of certain technology. Of all these tools, the Net Present Value (NPV) is the most efficient to accept the investment because it considers it more important to have a dollar today than tomorrow by generating returns early. Here are some examples to help you understand how it is calculated.the purchase of land or the acquisition of certain technology. Of all these tools, the Net Present Value (NPV) is the most efficient to accept the investment because it considers it more important to have a dollar today than tomorrow by generating returns early. Here are some examples to help you understand how it is calculated.
Investment in the company
A project for the construction of a building offers costs of $ 350,000.00 with the expectation of receiving $ 400,000.00 within a year at 7%. Would you go ahead if the present value of the expected $ 400,000.00 is greater than the investment of $ 350,000.00?
Data
r = 7%
C1 = $ 400,000.00
Co = $ 350,000.00
VA = $ 400,000.00 / 1.07
= $ 373 832.00
Therefore, at an interest rate of 7%, the VA of $ 400,000.00 within one year is $ 373,832.00
NPV = $ 373,832.00 - 350,000.00
= $ 23 832.00
R / If I accept the project, then the value of the investment will increase.
The NPV criterion is to accept projects that have a positive NPV (greater than zero) and reject projects that have negative NPV (less than zero).
NPV and value additivity
One of the attractions and also advantage of the current values is that they are all expressed in current dollars, so that they can be added, in other words, the current value of the cash flow A + B is equal to the VA of the cash flow A plus VA of flow B.
This result has important implications for investments that produce cash flows in various periods. We know how to calculate the VA of an asset that produces a C1 cash flow in one year (VA = C1 / 1 + r1) and the present value of another asset that produces a C2 cash flow after two years (VA = C2 / (1 + r2) 2). Following this additivity criterion, we can determine the value of an asset that produces cash flows in each year.
Would be:
VA = C1 x 1 + C2 x 1 + C3 x….
1+ r 1 (1+ r 2) 2
VA = C t / (1 + r t) t
VAN = Co + C t / (1 + r t) t
A factory costs $ 400,000.00. It is estimated that it will produce income after operating costs of $ 100,000.00 in the first year, $ 200,000.00 in the second year, and $ 300,000.00 in the third. The opportunity cost is 12%. Would you accept this project?
Year FT (CT) FD12% VA
1 100,000.00 x 0.893 = $ 89 300.00
2 200 000.00 x 0.797 = 159 400.00
3 300,000.00 x 0.712 = 213 600.00
$ 462 300.00
VAN = VA - CI
NPV = $ 462,300.00 - $ 400,000.00
NPV = $ 62,300.00
R / I would accept the investment project because the NPV is positive, which would increase the value of the company.
Now, there are times when it is very easy to calculate the present value (VA) of the yield that an asset will generate in a period, this is manifested in annuities and perpetuities. The first is the investment that generates fixed annual cash flows for a certain time, while perpetuities are those that give fixed flows each year indefinitely.
Mutually exclusive investments
It is normal for the company in its operations to be presented with several investment possibilities, but it will be a decision that it will make, discarding the other possibilities for that chosen one.
Independent projects are those whose cost and income are independent of each other. For example, in addition to its investment in warehouses, the company may need equipment to package its products (packaging machine) and the purchase of equipment for this purpose would be independent of the equipment purchased in for the warehouse. Project interrelationships can occur in myriad ways.
Bibliography:
- Fundamentals of Business Financing. Brealey RA and SC. Myers, 4th edition. Volumes I, II and III Fundamentals of Financial Management, 4th edition
