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
Absolute Return
Absolute return: the amount of money you make from an investment
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 Equity
Return on equity: the amount of money you make from an investment as a percentage of the value of the shares you own
Comparing Cashflows
- Time Value of Money (Net Present Value)
- 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
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
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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