The Investment Detective

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The Investment Detective

By | April 2009
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Case Study: The Investment Detective
Primary consideration is the capital availability. If the firm has unlimited access to capital and no other investment options, Net Present Value would become recommended quantitative method. On the other hand, if the time horizon and payback period matter, the company should use Internal Rate of Return Calculation. 1.Looking at the cash flows doesn’t really say much. The assumption is that the firm is in the business to make profit. Profit is equal return on investment cost of borrowing. If the WACC is 10% or higher, firm should make more than 10% as return on investment. Looking at the cash flows only gives an idea of how much excess of cash flow over initial investment is made. Implementing the time value of money, larger cash stream in first years are better. The year in which payback was accomplished plays key role in this case. Sooner the payback is accomplished, sooner the company can free up capital investment, use funds on different projects, and benefit from excess CF to be provided. Just by looking at CF I would rank investments in following order: 3, 4, 7, 1, 5, 8, 6, 2. This already involves some consideration of timeliness of cash streams. If we have only considered biggest cash flow yields the rank would be: 3, 5, 8, 4, 1, 7, 6, 2.

2.Timelines of cash flows is important with respect to reaching breakeven point. For this reason using the logarithm for Internal Rate of Return is the best quantitative method. Other quantitative methods are Net Present Value, Payback Period, Discounted Payback Period, and Profitability Index.  

3.Two most popular and technically correct ways to determine which investment options are the best: a.Calculating effective rate or return (IRR)
b.Discounting cash flows and finding net present value (NPV) Pr / Yr12345678

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