Investment Considerations And Methods

Six considerations that need to be taken into account before deciding to invest

Six considerations that need to take into account before deciding to invest

Capital investment decisions requires huge outflows of cash and management encounters various obstacles while making the decisions that involves acquisition of new assets or acquisition of company. There can be two main forms of investment that should be considered by the management. These forms of investment can be independent investment and exclusive investment. In independent investment, the implementation of the project will not impact the cash flows of other business units in the same company. On the other hand, taking up the exclusive investments will definitely impact the competing business units. For example, if company takes the decision of buying the company it will have impact on all the business units.

There are so many variables or factors that need to be considered but it is management duty to prioritize the most important factors that need to be considered before making the investment decision:

• Calculation and forecasting the cash flows or payoff: Firstly, it is important to consider the cash flows and payoff that will be created by the new investment. It can be done through market survey or performing detailed analysis of the project to be undertaken. If more than one project is under evaluation at the same time it is important to look after the project time period and investment needed by each project as these two factors can helps to judge two the mutually exclusive projects together. Project payoff can be evaluated through the application of payback method and accounting rate of return method. Payback period method helps to reveal the expected time required to recover the investment made in the project. While accounting rate of return will help to filter the best investment opportunities on the basis of return generated by the project. Both of these methods do not consider time value of money. As every project goes through various issues whether internal or external, it is the duty of management to develop the discounting model that takes up into consideration the external drivers and other important variables as per the business model (Higgins, 2012).
• Rate of Return and value of time: It is essential to consider the future cash flows of money and its present value. Net present value (NPV) method helps to evaluate the present value of future cash flows and initial investment. Net present value takes into account the time value of money as it discounts the future cash flows using the cost of capital of the company. Project is profitable when present value of cash inflows is greater than the present value of cash outflows.
• Assessing the acceptability of investment: It is essential to consider the internal rate of return of the project because it is the actual return that can be earned on the project if taken by the company. If IRR is greater than the cost of capital of the company than the project will profitable and will provide good return to company.
• Consider the tax effects on the company: It is important to make sure that all the cash flows used to evaluate the investment decisions must be after tax cash flows. Tax calculation must be accurate and dependable on the company maximum marginal tax rate applicable on the company. To make sure the accuracy of the cash flows it is important to have accountability on the cash flows calculations and it accuracy.
• Availability of resources: It is important to consider the availability of resources required to take up the project. Resources such as human capital, funds, technology, legal liabilities, and other pre-requisites are essential to take the project. It is management duty to look after these resources before taking up the projects. Any project with very high IRR and NPV is useless if it cannot be executed due to non availability of proper resources (Deegan, 2013).
• Competitive advantage: When any investment decision is taken whether buying the company or any fixed assets it is worth to look for the competitive advantage that such project will give. For example, change in technology can put the company one step ahead of competitor if such technology is not available with the competitor.

 The three methods of investment appraisal together with their advantage and disadvantages

Payback Period Method: This method investment appraisal is easy to calculate as it does not take into account the time value of money. This method provides the time taken to recover the initial investment through realizing the earnings from the project. This method is generally expressed in number of years and it can be calculated through dividing cumulative earnings of each year with the initial investment.

The main advantage of payback period method is that it is simple and easy to compute and very easy to understand. The most significant benefit of payback method is that it uses actual cash flows project to make the decision and this method make sure the availability from the project (Brigham and Houston, 2012).  

On the other hand, major disadvantage of payback method is that it does not consider the time value of money. The cash flows that are generated after the payback period is completely ignored that makes it useless for the cash flows generated. This method does not consider the length of investment that it is very important factor.

Net Present value: This method of investment appraisal is the most widely used method as it is considers time value of money which is ignored by payback method and accounting rate of return method. This method used the present values of cash flows to measure the profit generated by the project. In short it can be said that this method refers to the present value of expected future cash flows less the initial investment. Mostly the cost of capital of the company is taken as the discount rate for calculating the present value of future cash flows.

Payback Period Method

The major advantage of net present value of method is that it considers the time value of money which is the most significant consideration for any project. Unlike Internal rate of return method, NOV does not consider that cash flows generated during the project is again invested as it is quite impossible to reinvest the cash flows in project that provide similar returns to the company. Net present value method takes into account various risk factors that are important for any project (Brigham and Ehrhardt, 2013).

Net present value method does not take sunk cost as it is not regarded as an element of decision making. The change in cost of capital after the project is undertaken will be ignored and this project does not take into account the difference in size of project.

Internal Rate of Return: This method provides the percentage of rate which is actually earned on the project. When IRR is greater than the cost of capital the project is accepted otherwise it is not accepted.

The main advantage of this method is that it is based time value and takes into account that cash flows generated are available for reinvestment. On the other it is very difficult to calculate as it is based on some hurdle rate like cost of capital (Baker and Nofsinger, 2010).

Discussion of economic challenges of Brexit and the impact on Irish firms

‘Brexit’ is a term that refers to the exit of the UK from the European Union (EU) that was an economic and political partnership involving about 28 European countries.  EU was mainly developed for promoting economic co-operation between the member countries to ensure their sustainable and steady development by fostering greater trade and creating a single currency euro (Lee, 2016). The development of a single market by the creation of EU enables greater movement of good and people from one country to another and thus promoting the economic development. UK is however planning to leave the EU by the year 2019 for regaining its sovereignty and promoting internal migration and reducing the burden of economic regulations. The decision of the UK to leave the EU will have a larger impact on the economic and political well-being of the member countries.

It has been stated by the International Monetary Fund (IMF) that Ireland is regarded as one of the major country that would have a major significant economic impact of Brexit. As such, it is important to examine the significant impacts of Brexit on Ireland for assessing its future growth potential. The major potential risks exist in relation to the businesses of Ireland as UK is regarded as an important partner for Ireland that is measured in terms of both trade and investments (Ireland & the Impacts of Brexit, 2017). Irish exports as well as import a large number of goods and services to and from the UK and it are also regarded as an important destination for the FDI of Ireland. It is estimated that UK supports about 80,000 jobs within Ireland and therefore it can be stated that in comparison to other member countries of the EU it is highly dependent on trade with the UK. This makes Ireland highly vulnerable to negative impact of the Brexit causing the need for the country to diversify its trade base after UK leaves the EU (Lee, 2016).

Net Present value

IMF has estimated that Brexit could results in 50, 0000 jobs losses and a large drop in the economic output. It has been argued by various experts that a hard Brexit could result in deteriorating the peace within Ireland by negatively impacting the economic growth and development within the country. Hard Brexit refers to completely eliminating the close alignment between the UK and other member countries as it would result in leaving both the single market and the customs union. It has been predicted that in the scenario of hard Brexit the overall export would be declined to about 3.7 per cent below till the end of the year 2020 and thus have a negative impact on its GDP (Connelly, 2017). 

The intensity of the negative impact of Brexit would be larger within Ireland as it is having a common border with the UK and thus there exists a close value chain between the member countries. The SME’s of the Ireland are largely dependent on the UK for trade and therefore Brexit could negatively impact the chances of their future survival. The largest impact of the Brexit is estimated to be faced by the agri-food sector of the country as it is having large import dependency on the UK for certain specific food products such as beef, dairy and processed foods (Irish economy is growing substantially but Brexit ‘poses major threat, 2018). The announcement of the Brexit is already having a negative impact on the growth and development of the Irish companies with the sharp decline in the exchange rate between the countries. It would also impact the investment decisions of multinational companies as the companies that have invested to serve the UK market can consider relocation. It has been announced by the Irish Ministry of Finance that Brexit is estimated to cause a large negative material impact on the economy of Ireland. This is largely on account of the adverse effects on the Irish production and ultimately the GDP of the country. The high exposure of Brexit to the Ireland in terms of trade and investment could potentially result in degrading its economic performance. Thus, the government of the UK is recommended to adopt proactive measures for diversifying its trade base in order to regain its political and economic stability (Murphy, 2018).

References

Baker, H.K. and Nofsinger, J.R. 2010. Behavioral Finance: Investors, Corporations, and Markets. John Wiley & Sons.

Brigham, E.F. and Ehrhardt, M.C., 2013. Financial management: Theory & practice. Cengage Learning. 

Brigham, F., and Houston.J. 2012. Fundamentals of financial management. Cengage Learning.

Connelly, T. 2017. Brexit and Ireland: The Dangers, the Opportunities, and the Inside Story of the Irish Response. Penguin UK.

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.

Higgins, R. C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Ireland & The Impacts Of Brexit. 2017. [Online]. Available at: https://dbei.gov.ie/en/Publications/Publication-files/Ireland-and-the-Impacts-of-Brexit.pdf [Accessed on: 26 November 2018].

Irish economy is growing substantially but Brexit ‘poses major threat’. 2018. [Online]. Available at: https://www.thejournal.ie/irish-economy-brexit-risks-4070501-Jun2018/ [Accessed on: 26 November 2018].

Lee, T. 2016. Why did Britain vote to leave the EU? [Online]. Available at: https://www.vox.com/2016/6/25/12029962/why-did-britain-leave-the-eu [Accessed on: 26 November 2018].

Murphy, S. 2018. How brexit could affect the irish economy and possible solutions. . [Online]. Available at: https://irishtechnews.ie/how-brexit-could-affect-the-irish-economy-and-possible-solutions/ [Accessed on: 26 November 2018].