Investment is a core driver of both economic development and private sector business and investment appraisal plays a crucial part in ensuring that only the investments that should be undertaken are undertaken in actual fact. Both private and public investment projects/programs bring about specific social and organisational benefits and costs that can be quantified and which can be simulated from beforehand to ascertain the soundness of the investment under a certain set of assumptions and what happens to the business case if those assumptions break down. A major question that is usually asked and which needs to be answered prior to an investment decision is whether the investment is worth its while.
From an individualistic point of view, the rate of return that could be earned on the money to be invested if it had to be invested in a relatively safe-return, capital-guaranteed asset (e.g. a bank deposit account or Government bonds), rather than in the project, is the opportunity cost of the funds. This may be thought of as being the difference in the return that could have been earned if the money was invested elsewhere rather than being invested in the project that is being appraised. The market rate of interest (in reality there are several such rates, but they are all based on the base rate set by the Central Bank with jurisdiction over the particular currency through which the project will be undertaken) is an important determinant of the appraisal of an investment, as it is usually the rate at which the investor is borrowing money to fund the project and against which returns can most easily be compared. This rate is usually used as the discount rate in the calculation of the Net Present Value (NPV) of a project that is being appraised under the capital asset pricing model technique or under a variant thereof referred to as the real options technique. The NPV calculation will give an indication of whether the resources or funds used in the projects are being allocated efficiently. If the NPV is positive, the present value of the benefits of the project is greater than the opportunity cost.
Both the capital asset pricing model technique and the real options technique can be used to determine the best way to carry out an investment. Alternative projects may be considered and their individual NPVs can be compared to reach a final decision that will yield the best returns on investment. Other indicators such as the internal rate of return, the return on capital employed, and the benefit/cost ratio can also be applied to the appraisal of investment projects to give different dimensions. The discount rate that is applied is an important element of the NPV calculation, and in some cases, it would be necessary to apply a risk factor to this rate.
The results can then be stress-tested and the project can be subjected to rigorous risk analysis with a view to being able to determine which risks to take on, which ones to insure, and which ones to manage. For risks that will be managed, a decision needs to be made in terms of how to manage them and what contingencies to allow for the entire portfolio of risks of the project in view of the strategy that is to be adopted to deal with them.
The team at Equinox Advisory can assist you in your investment appraisal and decision-making processes by:
- Using their skills and experience in banking and finance, investment appraisal, economic valuation and Cost-Benefit Analysis to give a professional and detailed analysis of the project at hand;
- Formulating the discounting rate that should be applied to your project;
- Calculating the NPV of the project through the use of decision-making techniques such as the capital asset pricing model and the real options model;
- Helping you reach an informed decision that will lead to the acceptance or rejection of the project;
- Running feasibility studies for business relocations between countries;
- Advising on corporate structures and joint-venture agreements, where projects require such partnerships and strategic alliances to be struck, to ascertain that the mechanisms set into play do not break down in the future, with repercussions on prospective returns on investment; and
Advising you on which elements of the project, if any, may change to allow for the highest possible return on investment (project optimisation).