Investment Analysis

Topics: Net present value, Discounted cash flow, Internal rate of return Pages: 14 (3109 words) Published: February 23, 2013
Investment Analysis Tool [IAT] Instruction

This memo is intended as a help manual for users of the Investment Analysis Tool. It is my hope that this document will be sufficient to guide a new user through the functions of the IAT and even to feel comfortable enough to create new ways in which to use it for hospital investment decisions.

For ease of use, the memo is divided into the following sections:

I. Overview of Investment Analysis Tool
II. Instructions
III. Potential Uses
IV. Review of Investment Appraisal Methods


The Investment Analysis Tool [IAT] is a simple and straightforward pair of financial spreadsheets that can facilitate, streamline, and perhaps even standardize the capital budgeting process.

The IAT evaluates the attractiveness of a potential investment by analyzing its associated cash flows [i.e. inflows and outflows]. A user need only enter a few key variables regarding the investment and the spreadsheet automatically analyzes its attractiveness.

Three traditional investment appraisal methods are used by the IAT. They include: • Pay-back Period
• Internal Rate of Return (IRR)

Included in the IAT are two spreadsheets with slightly different functionality. They are named: 1). Automated
2). Manual

The main difference between these two worksheets lies in the way each creates future cash flows. The Automated worksheet does the projection of future cash flows automatically; while Manual requires the user to hand enter each data point [e.g. cash flow] for the life of the investment [i.e. investment analysis period]. Clearly, Manual is more complicated and time intensive than Automated. However, Manual is also more flexible, allowing for a greater variety of investments to be analyzed.

Regardless of which spreadsheet is used, the end goal of the tool remains the same: Analyzing investments using the same method to determine which investments are most attractive from a financial perspective.


A) Worksheet—AUTOMATED

First, it should be understood that AUTOMATED projects future cash flows for the user. Because of this feature, each year’s cash flows are the same (the worksheet does not include a growth rate input). Therefore, AUOTMATED should only be used for a rough estimation of an investment’s attractiveness. More detailed analyses should be conducted on the worksheet MANUAL.

i) Inputs


1) Initial investment: amount invested on Day 1
2) Depreciable life: time over which asset (i.e. investment) is depreciated - Primarily used for equipment
3) Estimated salvage value: amount asset can be sold for at the end of its useful life - Default value for this should be zero—a reflection of the asset being completely depreciated and the assumption that there is no resell market

Annual Cash Flows

1) Estimated additional revenue: incremental revenue generated by the new investment 2) Additional savings: incremental cost savings due to new investment. This could also be included in the additional input 3) Additional costs: incremental costs savings achieved by the new investment

Financing, Taxes, & Analysis

1) Borrowing interest rate: interest rate paid on loans received and invested. - If borrowing interest rate > 0, AUTOMATED assumes then entire initial investment amount is borrowed at this rate - If borrowing interest rate = 0, AUTOMATED assumes no money was borrowed to fund the investment 2) Tax rate: marginal tax rate for organization

3) Discount rate: refer to section IV. Review of Investment Appraisal Method

ii) Cash Flow Projections

This section is where the worksheet creates the cash flows. Living up to is name, AUOTMATED projects out future cash flows. Additionally, it calculates annual figures for: • Depreciation: based on the initial...
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