Investment Selection, Stock Management, and Economic Analysis
Investment Selection Methods
There are two important methods for investment selection:
- VC (Capital Value)
- NPV (Net Present Value)
VAN = -A + Q / (1 + K), where:
- A = Initial investment or payment
- Q = Cash flows
- K = Cost of capital or discount rate
If flows are undefined, the formula is: NPV = -To + Q / K.
The NPV decision criterion is:
- If NPV > 0, the project is carried out.
- If NPV < 0, the project is not carried out.
- If NPV = 0, one is indifferent to whether or not the project is carried out.
The drawback of this method is that it is sometimes difficult to estimate the value to be given to K.
TIR (Internal Rate of Return): is the rate that equals the capital value to 0 (0 = -A + Q / (1 + IRR)). The decision is made by comparing the IRR to the value of K from NPV, and there are 3 possibilities:
- If IRR > K, the project is carried out.
- If IRR < K, the project is not carried out.
- If IRR = K, one is indifferent to whether or not the project is carried out.
The drawback of this method is that it is sometimes very difficult to calculate TIR.
Stock Management
Stock management involves calculating the optimal amount that should be brought in with each order if the company buys from an outside source, or the amount that must be constructed if the company produces the product itself.
- D = Number of units demanded in each order.
- P = Price per unit cost.
- E = Costs of carrying out an order.
- A = Cost of storage, maintenance, or possession (must be for the entire period).
- i = Interest rate or cost of capital.
- Ts = Time supply.
- Q = Optimum lot size or order.
Formulas:
- Economic Lot Order: Q = 2 * E * D / (A + P * i)
- TC = P * D + E * D / Q + (A + P * i) * Q / 2
- Order No. = D / Q
- T. Resupply = (Number of days working the company / Number of orders)
- P.pedido = (Daily demand) * Ts; Daily demand = D / (Number of days working the company)
Note: In many cases, companies do not buy foreign products but make them themselves. Consider the following:
- D = Number of units demanded
- M = Number of units produced, where M > D (D and M for the whole period)
The costs to deliver each order in this case are the costs to initiate the manufacturing process.
Estimated the following:
- Economic Lot construction: Q = 2 * E * D / ((A + P * i) * (1 – D / M))
- CT = P * D + E * D / Q + (A + P * i) * Q / 2 * (1 – D / M)
- T. Manufacture = Q / M. Daily; M. Daily = M / (Number of days working the company)
- T. Consumption = Q / D. Daily; D. Daily = D / (Number of days working the company)
Economic Interpretation
Lori-Savage:
- Primal (X3 = 6, H2 = 18)
- Dual (U1 = 2.6, U2 = 0)
The three investments become 6 times because 6. Under X3 = 1 year, H1 = 0 because it is not the primal, no resources, so U1 = 2.6. The Company pays for additional units of resources. In year 2, H2 = 18, left over resources, so U2 = 0, and they do not pay for additional resource units.
Baumol: W1 = 0.95, W2 = 0.9
- Primal (X2 = 8, M2 = 26)
- Dual (U1 = 1.28, U2 = 0.9)
Investment 8 times. In year 1, U1 = 1.28 and W1 = 0.95. U1 > W1. The marginal profitability of the resources for the company is greater than for the shareholders; therefore, in this period, M1 = 0, and dividends are not distributed. In year 2, U2 = 0.9 and W2 = 0.9, matching the marginal profitability of the resources for the company and the shareholders; therefore, M2 = 26, and dividends are distributed.
Actions
Nominal Capital = Value of shares. Net assets = capital + reserves. Theoretical value or book equity = Equity / Number of actions