Investment Analysis: Characteristics, Types, and Valuation Methods

Posted on Jan 25, 2025 in Business Administration and Management (BAM)

Investment Characteristics

Investment Defined: The acquisition of an asset or service with the expectation of future financial returns. Investments are influenced by both capital and operational cycles.

Key Investment Features

  • Timing: Investments occur at a specific time, with results expected in the future.
  • Uncertainty: Returns are not guaranteed, involving a degree of risk.
  • Liquidity: The time it takes to convert an investment into cash.
  • Profitability: The comparison of resources used versus resources generated, reflecting the gain from the investment.
  • Risk: The uncertainty of achieving positive returns.

Relationship Between Liquidity, Profitability, and Risk

Direct Relationship: Higher potential returns often come with higher risk.

Inverse Relationship: Greater liquidity typically means lower profitability, and less liquidity often implies greater risk.

Types of Investments

By Asset Class

  • Long-Term Investments (ANC): Acquisition of assets like machinery, equipment, and land.
  • Short-Term Investments (AC): Investments in machinery, raw materials, and goods.

By Investment Purpose

  • Productive Investments: Aimed at developing a business activity.
  • Financial Investments: Focused on generating returns in financial markets.

Other Classifications

  • Maintenance or growth-oriented.
  • Autonomous, complementary, or alternative.
  • Physical/tangible or intangible.

Dynamic Methods of Investment Valuation

Net Present Value (NPV)

The sum of discounted cash flows minus the initial investment outlay. Formula: VAN = -A + Σ [Qn / (1 + K)n]

Internal Rate of Return (IRR)

The discount rate that makes the net present value of all cash flows from a particular project equal to zero.

Return on Net (RRN)

Calculated as: RRN = IRR – K

Discounted Recovery Period

The time it takes for the sum of discounted cash flows to exceed the initial investment.

Elements of an Investment

Down Payment (A)

The initial amount of money invested, influenced by available funds and project scope.

Duration of Investment

Investments are not indefinite and are typically divided into periods.

Cash Flow (Qi)

The difference between cash inflows and outflows during a specific period.

Capitalization and Discounting

Capitalization

Calculates the future value of a sum of money. Formula: Cn = Co (1 + k)n

Discounting

Calculates the present value of a future sum of money. Formula: Co = Cn / (1 + k)n

Static Methods of Investment Valuation

Recovery Time

The time it takes to recover the initial investment. Formula: A / Q (A = initial investment; Q = flow value)

Net Worth

The difference between the sum of the flows and the initial outlay. Formula: VN = -A + Σ Qi