Under investment or capital investment in the very general sense is understood as a temporary refusal of an economic entity from the consumption of resources (capital) at its disposal and the use of these resources to increase its well-being in the future.
The simplest example of investment is spending Money for the acquisition of property characterized by significantly less liquidity - equipment, real estate, financial or other non-current assets.
The main features of investment activity that determine approaches to its analysis are:
It is customary to distinguish between two types of investments: real and financial (portfolio). In the further presentation of the material, we will mainly talk about the first of them.
It should be noted that in the case of real investment, the condition for achieving the intended goals, as a rule, is the use (operation) of the relevant non-current assets for the production of certain products and their subsequent sale. This also includes, for example, the use of the organizational and technical structures of a newly formed business to make a profit in the course of the statutory activities of an enterprise created with the attraction of investments.
If the volume of investments turns out to be significant for a given economic entity in terms of its impact on its current and prospective financial condition, the adoption of appropriate management decisions should be preceded by the planning or design stage, that is, the stage of pre-investment studies, culminating in the development of an investment project.
An investment project is a plan or program of activities related to the implementation capital investments and their subsequent reimbursement and profit.
The task of developing an investment project is to prepare the information necessary for an informed decision-making regarding the implementation of investments.
The main method for achieving this goal is mathematical modeling of the consequences of making appropriate decisions.
For modeling purposes, the investment project is considered in a time base, and the analyzed period (research horizon) is divided into several equal intervals - planning intervals.
For each planning interval, budgets are compiled - estimates of receipts and payments, reflecting the results of all operations performed in this time period. The balance of such a budget - the difference between receipts and payments - is the cash flow of the investment project for a given planning interval.
If all components of the investment project are expressed in monetary value, we get a series of cash flow values that describe the process of implementing an investment project.
In the enlarged structure, the cash flow of an investment project consists of the following main elements:
At the initial stage of the project (investment period), cash flows, as a rule, turn out to be negative. This reflects the outflow of resources that occurs in connection with the creation of conditions for subsequent activities (for example, the acquisition of non-current assets and the formation of net working capital).
After the completion of the investment and the beginning of the operating period associated with the start of operation of non-current assets, the value cash flow tends to be positive.
Additional revenue from the sale of products, as well as additional production costs incurred during the implementation of the project, can be both positive and negative values. In the first case, this may be due, for example, to the closure of unprofitable production, when the decline in revenue is covered by cost savings. In the second case, a reduction in costs is modeled as a result of their savings during, for example, equipment upgrades.
Technically, the task of investment analysis is to determine what will be the amount of cash flows on a cumulative basis at the end of the established research horizon. In particular, it is fundamentally important whether it will be positive.
In investment analysis, the concepts of profit and cash flow, as well as the related concept of depreciation, play an important role.
The economic meaning of the concept of “profit” is that it is a capital gain. In other words, this is an increase in the welfare of an economic entity that manages a certain amount of resources. Profit is the main goal of economic activity.
As a rule, profit is calculated as the difference between the income received from the sale of products and services for a given time interval and the costs associated with the production of these products (rendering services).
It should be specially noted that in the theory of investment analysis the concept of “profit” (however, like many other economic concepts) does not coincide with its accounting and fiscal interpretation.
In investment activity, the fact of making a profit is preceded by the reimbursement of the initial investment, which corresponds to the concept of “amortization” (in English, the word “amortization” means “repayment of the main part of the debt”). In case of investment in fixed assets This function is performed by depreciation deductions.
Thus, the justification for fulfilling the main requirements for a project in the field of real investment is based on the calculation of the amounts of depreciation and profit within the established research horizon. This amount, in the most general case, will be the total cash flow of the operating period.
The concept of “cost of capital” is closely related to economic concept"profit".
The value of capital in the economy lies in its ability to create added value, that is, to make a profit. This value in the relevant market - the capital market - determines its value.
Thus, the cost of capital is the rate of return that determines the value of disposing of capital over a certain period of time (usually a year).
In the simplest case, when one of the parties (seller, lender, creditor) transfers the right to dispose of capital to another party (buyer, borrower), the cost of capital is expressed in the form of an interest rate.
The interest rate is determined based on market conditions (that is, the availability of alternative options for using capital) and the degree of risk of this option. At the same time, one of the components market value capital turns inflation.
When performing calculations at constant prices, the inflation component can be excluded from the interest rate. To do this, use one of the modifications of the well-known Fisher formula:
where r– real interest rate, n- nominal interest rate, i is the rate of inflation. All rates and inflation rates in this formula are given as decimals and must refer to the same time period.
In general, the interest rate corresponds to the share of the principal amount of the debt (principal), which must be paid at the end of the billing period. Bets of this kind are called simple.
Interest rates that differ in the duration of the settlement period can be compared with each other through the calculation of effective rates or rates compound interest.
The effective rate is calculated according to the following formula:
,
where e – effective rate, s – simple rate, N– the number of periods for calculating interest within the interval under consideration.
The most important component of the cost of capital is the degree of risk. It is precisely because of the various risks associated with various forms, directions and terms of capital use that the capital market at any given time can experience various estimates its value.
The concept of "discounting" is one of the key ones in the theory of investment analysis. The literal translation of this word from English (“discounting”) means “cost reduction, markdown”.
Discounting is the operation of calculating the present value (the English term “present value” can also be translated as “present value”, “present value”, etc.) of amounts of money relating to future periods of time.
The opposite of discounting, the calculation of the future value of an initial amount of money, is called accretion or compounding and is easily illustrated by an example of an increase in the amount of debt over time at a given interest rate:
,
where F- future, and P- the modern value (initial value) of the amount of money, r– interest rate (in decimal terms), N- the number of interest periods.
The transformation of the above formula in the case of solving the inverse problem looks like this:
Discounting methods are used if it is necessary to compare values cash receipts and payments spread over time. In particular, the key criterion for investment efficiency - net present value (NPV) - is the sum of all cash flows (receipts and payments) arising during the period under review, reduced (recalculated) at one point in time, which is usually chosen as moment of commencement of the investment.
As follows from what has been said above, the interest rate used in the formula for calculating the present value is no different from the usual rate, which in turn reflects the cost of capital. In the case of using discount methods, this rate, however, is usually referred to as the discount rate ( possible options: “comparison rate”, “barrier rate”, “discount rate”, “reduction factor”, etc.).
A qualitative assessment of the effectiveness of an investment project largely depends on the choice of the discount rate. Exists a large number of various methods to justify the use of one or another value of this rate. In the most general case, you can specify the following options for choosing a discount rate:
The rates listed above differ mainly in the degree of risk, which is one of the components of the cost of capital. Depending on the type of discount rate chosen, the results of calculations related to the assessment of the effectiveness of investments should also be interpreted.
The main goal of evaluating an investment project is to substantiate its commercial (entrepreneurial) viability. The latter involves the fulfillment of two fundamental requirements:
It is necessary to distinguish between two components of the commercial viability of an investment project, its necessary and sufficient conditions, respectively:
An economic assessment or an assessment of the effectiveness of capital investment is aimed at determining the potential of the project under consideration to provide the required or expected level of profitability.
When performing investment analysis, the task of evaluating the effectiveness of capital investments is the main one that determines the fate of the project as a whole.
The financial assessment is aimed at choosing a scheme for financing the project and thus characterizes the possibilities for realizing the economic potential of the project.
The evaluation should follow economic approach and consider only those benefits and losses that can be measured in monetary terms.
The investment project development cycle can be represented as a sequence of three stages (stages):
Each stage has its own tasks. As you move through the stages, the idea of the project is refined and enriched with new information. Thus, each stage is a kind of intermediate finish: the results obtained at it should serve as confirmation of the feasibility of the project and, thus, are a “pass” to the next stage of development.
At the first stage, the possibility of implementing the project is assessed from the point of view of marketing, production, legal and other aspects. The initial information for this is information about the macroeconomic environment of the project, the intended sales market for products, technologies, tax terms etc. The result of the first stage is a structured description of the project idea and a time schedule for its implementation.
The second stage in most cases is decisive. Here, the evaluation of the effectiveness of investments and the determination of the possible cost of the capital involved. The initial information for the second stage is the schedule of capital investments, sales volumes, current (production) costs, the need for working capital, and the discount rate. The results of this stage are most often presented in the form of tables and investment performance indicators: net present value (NPV), payback period, internal rate of return (IRR).
This stage of the project evaluation corresponds to the computer model “MASTER PROJECTS: Preliminary evaluation”.
The last - third - stage is associated with the choice of the optimal scheme for financing the project and the assessment of the effectiveness of investments from the position of the owner (holder) of the project. For this, information is used on interest rates and loan repayment schedules, as well as the level of dividend payments, etc. The results of the financial evaluation of the project should be: financial plan project implementation, forecast forms financial reporting and indicators of financial solvency. The computer model “MASTER PROJECTS: Budget Approach” corresponds precisely to this stage of project evaluation.
Any method of investment analysis involves considering the project as a conditionally independent economic object. Therefore, at the first two stages of development, an investment project should be considered separately from the rest of the activities of the enterprise that implements it.
The isolated (local) nature of the consideration of projects excludes the possibility of a correct choice of schemes for their financing. This is due to the fact that the decision to attract one or another source for financing capital investments is made, as a rule, at the level of the enterprise as a whole or its financially independent division. In this case, first of all, the current financial condition of this enterprise is taken into account, which is almost impossible to reflect in a local project.
Thus, on large enterprises the task of choosing a financing scheme for an investment project (at least for projects classified as “large”) is necessarily left to highest level management. At the level of middle management, the task remains to select the most effective, that is, the most potentially profitable projects from the existing list.
We are returning to the issues of development strategy, investment policy, evaluation of the effectiveness of investment projects. An integral part of business management is an end-to-end analytical tool that the company's management always uses when it comes to making a decision. This special systemic function, based on accounting, is used for various purposes, the main of which are related to real investments. Investment analysis as a comprehensive providing means of the investment process is considered in this article.
I like to refer to the fundamental concepts of management events and actions. Why? Probably because without scientific knowledge it is quite difficult to understand the subtle "matters" of investment practice. And one of the postulates of this knowledge is the understanding of the subject of the studied categories, the concepts of which make it possible to build axiomatic foundations for the development of methodology. We are in the conceptual field of the investment sphere, and to the adjective "investment" we can add:
Concepts are the essence of the phenomenon, and if the semantics of phrases are different, it means that they have excellent content behind them, which has a special meaning in practice. Pay attention to whichever concept from the presented list we take, the analysis is relevant to each of them. Let's analyze the phrase "investment analysis" (IA) by elements. From the position scientific method analysis (from analysis (Greek) - dismemberment, decomposition) is the process of mentally dividing the object under study into parts. The analyst asks: "And what happens in essence, what are the structure, composition, properties and relationships of the parts of the object?" The essence never lies on the surface, which means that the object of study must be dissected or divided into parts.
Model of an analytic-synthetic procedure. Source: Textbook for MBA students. Author - Goncharova S.G.
As you know, the correctness of the analysis is determined by the results of the synthesis of the object, which allows to some extent clarify the essence of the object, compare it with other similar objects according to the criteria of analysis and synthesis. Next, consider the adjective "investment". It defines the specifics of the analysis associated with decisions at higher and lower levels of their adoption from strategy to specific tasks of the project type. The expressed position defines the foundations of the concept of investment analysis.
In applied terms, we understand IA as a complex analytical activity aimed at obtaining a justification for making an effective investment decision. Systems and methods of investment analysis reproduce the methodology of financial and economic analysis, of which they are a part. Strategic type of IA, evaluation investment programs, projects and individual operations form two interconnected contours of analytical and evaluation procedures.
In connection with the presence of several circuits associated with investments, the division of analysis into types is of particular importance. The following is a classification of AI based on a number of features. The main features are the level and moment of the procedure, regardless of its type.
Classification of IA types in commercial organization
The content and structure of investment analysis is largely determined by its subjects, subject and objects. Under the subjects of IA, we will understand the persons who directly make the analysis, and the circle of participants in whose interests it is performed. At the same time, we will divide the performers into persons participating in strategic IA and persons performing investment analysis related to project selection and real investments. The analysis that precedes the development of an investment strategy involves:
In IAs performed at the project level, the named managers are assigned more of a supervising function, and the direct execution of the analysis is carried out by:
The structure of the services participating in the IA of projects can be universal and be formed for the campaign of selection and selection of projects in the portfolio, or it can be created for each project in a unique format. IA is also performed by specialized divisions of external stakeholders: banks, consulting and insurance companies. The subjects that make decisions based on the results of the performed IA include:
The subject of IA is determined by causal relationships financial processes flowing as a result of the investment activity of the company, the parameters of the accompanying socio-economic efficiency. The results of the conducted research make it possible to correctly assess the directions and sizes of investments, substantiate business plans, and find reserves for improving processes. IA objects are the results of actions of the corresponding level.
The structure of IA system options in a company depends on the industry, the scale of the enterprise, and the level of development of regular management. As a rule, it is built from the top down from the strategy and from the current moment to the future, in which a retrospective analysis is carried out upon the implementation of project tasks. An example of the composition and relationships of IAs is shown below.
A variant of the composition and interrelations of the IA of a mid-level company
The development of an investment strategy is part of the overall strategic process. Before decisions in this area can be made, a strategic investment position model must be established. It comprehensively characterizes the possibilities for the development of an enterprise in priority areas for the development of investment activities. Systems and methods of investment analysis for strategy development are divided into three blocks. The first block is related to the study of the macro- and microenvironment of the company in order to obtain a complete picture of the investment environment in which it operates:
The second block of IA has a dual nature and uses the foundations of financial strategic analysis. It forms the prerequisites for decisions on the overall financial development strategy and on the local investment strategy. The content of this group is determined by the following models and methods:
The third block of strategic IA provides a solution to the problem of finalizing ideas, investment directions, and identified uncertainties. This block uses three types of analysis: portfolio, scenario and expert. Portfolio analysis refers to the stage of marketing analysis, at which business units are compared and recommendations are made on the priorities for allocating resources for their development.
When conducting research, there are almost always several areas of strategic uncertainty that can carry serious threats to future implementation. The scenario method of IA allows to avoid them. The simplest technique is based on the consideration of three scenarios as a result of investment models of the pessimistic, optimistic and most probable scenarios.
The types of the first block are well known from strategic management, so I will limit myself to the characteristics of the IA methods of the financial block. The SOFIA model is not only a set of financial strategic management methods, but also an integral system financial management, which focuses on the investment strategy, its evaluation and implementation. The main components of this system are shown below.
Composition of SOFIA system components
The sustainable growth model of a firm assesses the proportionate growth rates of sales revenue, profits, assets, equity, and company debt. The method allows preparing decisions on strategic balancing of finances, including in the investment sphere. Valuation of the company allows you to evaluate the effectiveness of business management in past periods. With the help of matrixes of financial strategic models (authorship of BCG), an understanding arises whether the company has investment opportunities or not.
Simplified diagram of the matrix of financial strategic models
Analysis of investment projects main task puts the receipt of conclusions that allow you to select projects for implementation, ensure the achievement of the intended results in the course of monitoring the implementation and adjust the investment process following the results of their closure. Below is an algorithm for choosing a project based on IA. Analysis of the effectiveness of investment projects occupies the central part of the financial and economic analysis, which, in turn, is the main IA in the system integrated assessment plan of strategic investment measures.
Algorithm for accepting an investment project for execution based on the results of the IA
The local tasks of the project IA include the following.
General model of financial and economic analysis with the transition to project IA
Above is a figurative model of the transition from the three strategies to the methods of IA projects based on performance parameters. It should be emphasized that the methods of analysis of investment projects are based on the assessment of cash flows as real events of a practical plane. This IA differs, for example, from the analysis economic activity enterprises. AHD bases its research on the income-expenditure concept of performance evaluation, based on the accrual principle, rather than cash flow.
Among the applied methods of IA projects, the following types of analyzes and evaluation should be mentioned:
In this article, we examined investment analysis in a commercial organization from the perspective of two levels: strategic and project. Naturally, both of these aspects are closely interrelated and constitute a logical sequence from the development of an investment strategy and policy to the solution of specific project tasks. “Overboard” of our attention was the IA of financial investments, and this is not a problem, since articles on this topic are planned. In any case, in my opinion, the introduction to the subject area of investment analysis took place, and we got the opportunity to further analyze specific applied tools in detail.
Under investment or investment in the most general sense, it is understood as a temporary refusal of an economic entity from the consumption of resources (capital) at its disposal and the use of these resources to increase its well-being in the future. The simplest example of investment is spending money on the acquisition of property characterized by significantly less liquidity - equipment, real estate, financial or other non-current assets.
The main features of investment activity that determine approaches to its analysis are:
It is customary to distinguish between two types of investments: real and financial(portfolio). In the further presentation of the material, we will mainly focus on the first of them.
It should be noted that in the case of real investment, the condition for achieving the intended goals, as a rule, is the use (operation) of the relevant non-current assets for the production of certain products and their subsequent sale. This also includes, for example, the use of the organizational and technical structures of a newly formed business to make a profit in the course of the statutory activities of an enterprise created with the attraction of investments.
Investment project
If the volume of investments turns out to be significant for a given economic entity in terms of its impact on its current and prospective financial condition, the adoption of appropriate management decisions should be preceded by the planning or design stage, that is, the stage of pre-investment research, culminating in the development of an investment project. investment project called a plan or program of measures related to the implementation of capital investments and their subsequent reimbursement and profit.
The task of developing an investment project is to prepare the information necessary for an informed decision-making regarding the implementation of investments. The main method for achieving this goal is mathematical modeling of the consequences of making appropriate decisions.
Budget Approach and Cash Flows. For modeling purposes, the investment project is considered in a time base, and the analyzed period (research horizon) is divided into several equal intervals - planning intervals. For each planning interval, budgets are compiled - estimates of receipts and payments, reflecting the results of all operations performed in this time period.
The balance of such a budget - the difference between receipts and payments - is the cash flow of the investment project for a given planning interval. If all the components of the investment project are expressed in monetary value, we will get a series of cash flow values that describe the process of implementing the investment project.
In the enlarged structure, the cash flow of an investment project consists of the following main elements: Investment costs. Revenue from the sale of products. Production costs. Taxes.
At the initial stage of the project (investment period), cash flows, as a rule, turn out to be negative. This reflects the outflow of resources that occurs in connection with the creation of conditions for subsequent activities (for example, the acquisition of non-current assets and the formation of net working capital).
After the completion of the investment and the beginning of the operating period associated with the start of the operation of non-current assets, the amount of cash flow, as a rule, becomes positive. Additional revenue from the sale of products, as well as additional production costs incurred during the implementation of the project, can be both positive and negative values. In the first case, this may be due, for example, to the closure of unprofitable production, when the decline in revenue is covered by cost savings. In the second case, a reduction in costs is modeled as a result of their savings during, for example, equipment upgrades.
Technically, the task of investment analysis is to determine what will be the amount of cash flows on a cumulative basis at the end of the established research horizon. In particular, it is fundamentally important whether it will be positive.
Profit and depreciation. In investment analysis, the concepts of profit and cash flow, as well as the related concept of depreciation, play an important role.
The economic meaning of the concept of "profit" is that it is a capital gain. In other words, this is an increase in the welfare of an economic entity that manages a certain amount of resources. Profit is the main goal of economic activity.
As a rule, profit is calculated as the difference between the income received from the sale of products and services for a given time interval and the costs associated with the production of these products (rendering services).
It should be specially noted that in the theory of investment analysis the concept of "profit" (however, like many other economic concepts) does not coincide with its accounting and fiscal interpretation.
In investment activity, the fact of making a profit is preceded by the reimbursement of the initial investment, which corresponds to the concept of "depreciation" (in English, the word "amortization" means: repayment of the main part of the debt). In the case of investing in non-current assets, this function is performed by depreciation.
Thus, the justification for fulfilling the main requirements for a project in the field of real investment is based on the calculation of the amounts of depreciation and profit within the established research horizon. This amount, in the most general case, will be the total cash flow of the operating period.
Cost of capital and interest rates. The concept of "cost of capital" is closely related to the economic concept - profit.
The value of capital in the economy lies in its ability to create added value, that is, to make a profit. This value in the relevant market - the capital market - determines its value.
Thus, the cost of capital is the rate of return that determines the value of disposing of capital over a certain period of time (usually a year).
In the simplest case, when one of the parties (seller, lender, creditor) transfers the right to dispose of capital to another party (buyer, borrower), the cost of capital is expressed in the form of an interest rate.
The interest rate is determined based on market conditions (that is, the availability of alternative options for using capital) and the degree of risk of this option.
At the same time, one of the components of the market value of capital is inflation. When performing calculations at constant prices, the inflation component can be excluded from the interest rate. To do this, one should use one of the modifications of the well-known Fisher's formulas:
Where r is the real interest rate, n is the nominal interest rate, i is the inflation rate.
All rates and inflation rates in this formula are given as decimals and must refer to the same time period.
In general, the interest rate corresponds to the share of the principal amount of the debt (principal), which must be paid at the end of the billing period. Bets of this kind are called simple.
Interest rates that differ in the duration of the settlement period can be compared with each other through the calculation of effective rates or compound interest rates. The effective rate is calculated according to the following formula:
, where e is the effective rate, s is the simple rate, N is the number of interest periods within the considered interval.
The most important component of the cost of capital is the degree of risk. It is due to the different risks associated with different forms, directions and terms of capital use that different assessments of its value can be observed in the capital market at any given time.
Discounting
The concept of "discounting" is one of the key in the theory of investment analysis. The literal translation of this word from English (“discounting”) means: cost reduction, markdown. Discounting is the operation of calculating the present value (the English term “present value” can also be translated as “true value”, “present value”, etc.) amounts of money relating to future periods of time
The opposite of discounting, the calculation of the future value of an initial amount of money, is called accretion or compounding, and is easily illustrated by an example of an increase in the amount of debt over time at a given interest rate: F = P * (1+r)N
where F is the future, and P is the present value (initial value) of the amount of money, r is the interest rate (in decimal terms), N is the number of interest periods.
The transformation of the above formula in the case of solving the inverse problem looks like this: P = F / (1+r)N
Discounting methods are used if it is necessary to compare the amounts of cash receipts and payments spaced over time. In particular, the key criterion for investment efficiency - net present value (NPV) - is the sum of all cash flows (receipts and payments) arising during the period under review, reduced (recalculated) at one point in time, which is usually chosen as moment of commencement of the investment.
As follows from what has been said above, the interest rate used in the formula for calculating the present value is no different from the usual rate, which in turn reflects the cost of capital. In the case of using discount methods, this rate, however, is usually called the discount rate (possible options: "comparison rate", "barrier rate", "discount rate", "reduction factor", etc.).
A qualitative assessment of the effectiveness of an investment project largely depends on the choice of the discount rate. There are a large number of different methods to justify the use of one or another value of this rate. In the most general case, you can specify the following options for choosing a discount rate:
The rates listed above differ mainly in the degree of risk, which is one of the components of the cost of capital. Depending on the type of discount rate chosen, the results of calculations related to the assessment of the effectiveness of investments should also be interpreted.
Tasks of evaluation of the investment project
The main goal of evaluating an investment project is to substantiate its commercial (entrepreneurial) viability. The latter involves the fulfillment of two fundamental requirements:
It is necessary to distinguish between two components of the commercial viability of an investment project, its necessary and sufficient conditions, respectively:
An economic assessment or an assessment of the effectiveness of capital investment is aimed at determining the potential of the project under consideration to provide the required or expected level of profitability. When performing investment analysis, the task of evaluating the effectiveness of capital investments is the main one that determines the fate of the project as a whole.
The financial assessment is aimed at choosing a scheme for financing the project and thus characterizes the possibilities for realizing the economic potential of the project. The assessment should follow an economic approach and consider only those benefits and losses that can be measured in monetary terms.
Investment project evaluation stages
The investment project development cycle can be represented as a sequence of three stages (stages):
As you move through the stages, the idea of the project is refined and enriched with new information. Thus, each stage is a kind of intermediate finish: the results obtained at it should serve as confirmation of the feasibility of the project and, thus, are a "pass" to the next stage of development.
On the first stage there is an assessment of the possibility of implementing the project in terms of marketing, production, legal and other aspects. The initial information for this is information about the macroeconomic environment of the project, the intended market for the product, technologies, tax conditions, etc. The result of the first stage is a structured description of the project idea and a time schedule for its implementation.
Second stage in most cases is decisive. Here, the evaluation of the effectiveness of investments and the determination of the possible cost of the capital involved. The initial information for the second stage is the schedule of capital investments, sales volumes, current (production) costs, the need for working capital, and the discount rate. The results of this stage are most often presented in the form of tables and investment performance indicators: net present value (NPV), payback period, internal rate of return (IRR).
Third stage is associated with the choice of the optimal scheme for financing the project and the evaluation of the effectiveness of investments from the position of the owner (holder) of the project. For this, information is used on interest rates and loan repayment schedules, as well as the level of dividend payments, etc. The results of the financial assessment of the project should be: a financial plan for the implementation of the project, forecast forms of financial statements and indicators of financial solvency.
Any method of investment analysis involves considering the project as a conditionally independent economic object. Therefore, at the first two stages of development, an investment project should be considered separately from the rest of the activities of the enterprise that implements it.
The isolated (local) nature of the consideration of projects excludes the possibility of a correct choice of schemes for their financing. This is due to the fact that the decision to attract one or another source for financing capital investments is made, as a rule, at the level of the enterprise as a whole or its financially independent division. In this case, first of all, the current financial condition of this enterprise is taken into account, which is almost impossible to reflect in a local project.
Thus, at large enterprises, the task of choosing a financing scheme for an investment project (at least for projects classified as “large”) necessarily goes to the highest level of management. At the level of middle management, the task remains to select the most effective, that is, the most potentially profitable projects from the existing list.
Investments and capital investments
In the most general sense, investments or capital investments are understood as a temporary refusal of an economic entity from the consumption of resources (capital) at its disposal and the use of these resources to increase its welfare in the future.
The simplest example of investment is spending money on the acquisition of property characterized by significantly less liquidity - equipment, real estate, financial or other non-current assets.
The main features of investment activity that determine approaches to its analysis are:
It is customary to distinguish between two types of investments: real and financial (portfolio). In the further presentation of the material, we will mainly talk about the first of them.
It should be noted that in the case of real investment, the condition for achieving the intended goals, as a rule, is the use (operation) of the relevant non-current assets for the production of certain products and their subsequent sale. This also includes, for example, the use of the organizational and technical structures of a newly formed business to make a profit in the course of the statutory activities of an enterprise created with the attraction of investments.
Investment project
If the volume of investments is significant for a given economic entity in terms of its impact on its current and prospective financial condition, the adoption of appropriate management decisions should be preceded by the planning or design stage, that is, the stage of pre-investment studies, culminating in the development of an investment project.
An investment project is a plan or program of activities related to the implementation of capital investments and their subsequent reimbursement and profit.
The task of developing an investment project is to prepare the information necessary for an informed decision-making regarding the implementation of investments.
The main method for achieving this goal is mathematical modeling of the consequences of making appropriate decisions.
Budget Approach and Cash Flows
For modeling purposes, an investment project is considered in a time base, and the analyzed period (research horizon) is divided into several equal intervals - planning intervals.
For each planning interval, budgets are compiled - estimates of receipts and payments, reflecting the results of all operations performed in this time period. The balance of such a budget - the difference between receipts and payments - is the cash flow of the investment project for a given planning interval.
If all the components of the investment project are expressed in monetary value, we will get a series of cash flow values that describe the process of implementing the investment project.
In the enlarged structure, the cash flow of an investment project consists of the following main elements:
At the initial stage of the project (investment period), cash flows, as a rule, turn out to be negative. This reflects the outflow of resources that occurs in connection with the creation of conditions for subsequent activities (for example, the acquisition of non-current assets and the formation of net working capital).
After the completion of the investment and the beginning of the operating period associated with the start of the operation of non-current assets, the amount of cash flow, as a rule, becomes positive.
Additional revenue from the sale of products, as well as additional production costs incurred during the implementation of the project, can be both positive and negative values. In the first case, this may be due, for example, to the closure of unprofitable production, when the decline in revenue is covered by cost savings. In the second case, a reduction in costs is modeled as a result of their savings during, for example, equipment upgrades.
Technically, the task of investment analysis is to determine what will be the amount of cash flows on a cumulative basis at the end of the established research horizon. In particular, it is fundamentally important whether it will be positive.
Profit and depreciation
In investment analysis, the concepts of profit and cash flow, as well as the related concept of depreciation, play an important role.
The economic meaning of the concept of "profit" is that it is a capital gain. In other words, this is an increase in the welfare of an economic entity that manages a certain amount of resources. Profit is the main goal of economic activity.
As a rule, profit is calculated as the difference between the income received from the sale of products and services for a given time interval and the costs associated with the production of these products (rendering services).
It should be specially noted that in the theory of investment analysis the concept of "profit" (however, like many other economic concepts) does not coincide with its accounting and fiscal interpretation.
In investment activity, the fact of making a profit is preceded by the reimbursement of the initial investment, which corresponds to the concept of "amortization" (in English, the word "amortization" means "repayment of the main part of the debt"). In the case of investing in non-current assets, this function is performed by depreciation.
Thus, the justification for fulfilling the main requirements for a project in the field of real investment is based on the calculation of the amounts of depreciation and profit within the established research horizon. This amount, in the most general case, will be the total cash flow of the operating period.
Cost of capital and interest rates
The concept of "cost of capital" is closely related to the economic concept of "profit".
The value of capital in the economy lies in its ability to create added value, that is, to make a profit. This value in the relevant market - the capital market - determines its value.
Thus, the cost of capital is the rate of return that determines the value of disposing of capital over a certain period of time (usually a year).
In the simplest case, when one of the parties (seller, lender, creditor) transfers the right to dispose of capital to another party (buyer, borrower), the cost of capital is expressed in the form of an interest rate.
The interest rate is determined based on market conditions (that is, the availability of alternative options for using capital) and the degree of risk of this option. At the same time, one of the components of the market value of capital is inflation.
When performing calculations at constant prices, the inflation component can be excluded from the interest rate. To do this, use one of the modifications of the well-known Fisher formula:
Where r is the real interest rate, n- nominal interest rate, i- the rate of inflation. All rates and inflation rates in this formula are given as decimals and must refer to the same time period.
In general, the interest rate corresponds to the share of the principal amount of the debt (principal), which must be paid at the end of the billing period. Bets of this kind are called simple.
Interest rates that differ in the duration of the settlement period can be compared with each other through the calculation of effective rates or compound interest rates.
The effective rate is calculated according to the following formula:
,
where e- effective rate, s- simple bet N- the number of periods of interest accrual within the considered interval.
The most important component of the cost of capital is the degree of risk. It is due to the different risks associated with different forms, directions and terms of capital use that different assessments of its value can be observed in the capital market at any given time.
Discounting
The concept of "discounting" is one of the key in the theory of investment analysis. The literal translation of this word from English ("discounting") means "cost reduction, markdown".
Discounting is the operation of calculating the present value (the English term "present value" can also be translated as "present value", "present value", etc.) of amounts of money relating to future periods of time.
The opposite of discounting, the calculation of the future value of an initial amount of money, is called accretion or compounding, and is easily illustrated by an example of an increase in the amount of debt over time at a given interest rate:
,
where F- future, and P- the modern value (initial value) of the amount of money, r- interest rate (in decimal terms), N- the number of interest periods.
The transformation of the above formula in the case of solving the inverse problem looks like this:
Discounting methods are used if it is necessary to compare the amounts of cash receipts and payments spaced over time. In particular, the key criterion for investment efficiency - net present value (NPV) - is the sum of all cash flows (receipts and payments) arising during the period under review, given (recalculated) at one point in time, which is usually chosen as moment of commencement of the investment.
As follows from what has been said above, the interest rate used in the formula for calculating the present value is no different from the usual rate, which in turn reflects the cost of capital. In the case of using discount methods, this rate, however, is usually called the discount rate (possible options: "comparison rate", "barrier rate", "discount rate", "reduction factor", etc.).
A qualitative assessment of the effectiveness of an investment project largely depends on the choice of the discount rate. There are a large number of different methods to justify the use of one or another value of this rate. In the most general case, you can specify the following options for choosing a discount rate:
The rates listed above differ mainly in the degree of risk, which is one of the components of the cost of capital. Depending on the type of discount rate chosen, the results of calculations related to the assessment of the effectiveness of investments should also be interpreted.
