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Introduction

Introduction

Steps of investments

Alternatives

Opportunity costs: potential returns of the next best alternative

  • Are there any alternatives?
  • Is it the best investment?
  • Is it worth it?
  • Can I look somehwere else?

Cost of Capital

Financing plan: raise capital to fund the investment

  • How much capital do I need?
  • How much will it cost?
  • How will I raise the capital?

Certainty of predictions

Level of certainty: how sure are you that the investment will be successful?

  • How certain am I that the investment will be successful?
  • How much risk am I willing to take?
  • How much risk can I afford to take?

Financing

Equity

Equity: the value of the shares issued by a company

  • How much do I have?
  • What alternatives?

Debt

Debt: the amount of money borrowed by a company

  • How much can I borrow?
  • Conditions to borrow? (Interest Rate)

Returns

Investment Return

Investment return: the amount of money you make from an investment as a percentage of the purchase price

Investment Return=Annual IncomePurchase Price+Cost×100\text{Investment Return} = \frac{\text{Annual Income}}{\text{Purchase Price} + \text{Cost}} \times 100

Absolute Return

Absolute return: the amount of money you make from an investment

Absolute Return=Annual Income\text{Absolute Return} = \text{Annual Income}

Return on Interested Capital

Return on interested capital: the amount of money you make from an investment as a percentage of the amount of money you invested

Return on Interested Capital=Annual IncomeInvested Capital×100\text{Return on Interested Capital} = \frac{\text{Annual Income}}{\text{Invested Capital}} \times 100

Return on Equity

Return on equity: the amount of money you make from an investment as a percentage of the value of the shares you own

Return on Equity=Annual IncomeEquity×100\text{Return on Equity} = \frac{\text{Annual Income}}{\text{Equity}} \times 100

Comparing Cashflows

  1. Time Value of Money (Net Present Value)
  2. Risk (risk adjusted discount rate)

Net Present Value (NPV)

NPV needs to be > 0 in order to maximize value creation

Net Present Value: the value of future cashflows in today's money

NPV=t=1Future Cashflow(1+t)n\text{NPV} = \sum_{t=1}^{} \frac{\text{Future Cashflow}}{(1 + \text{t})^{\text{n}}}

n = duration of investment t = discount rate (usually 10%)

Internal Rate of Return (IRR)

IRR needs to > 10% in order to maximize relative period return

Internal Rate of Return: the discount rate that makes the NPV = 0

NPV=0=t=1Future Cashflow(1+IRR)n\text{NPV} = 0 = \sum_{t=1}^{} \frac{\text{Future Cashflow}}{(1 + \text{IRR})^{\text{n}}}

IRR=(CFInitialn1)×100\text{IRR} = (\sqrt[n]{\frac{\text{CF}}{\text{Initial}}} - 1) \times 100

Payback Period

Payback needs to be the smallest in order to minimize payback time

Payback Period: the amount of time it takes to recover the initial investment

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