Strategic Investment Decision

Group 6: Hudzaifah, Afiqah, Samineh, Firdaus, Sara, Meysam, Mario, Yousef, Abdelazizim

Introduction
What is Capital Budgeting?
Capital refer to fixed assets used in production

Budget is a plan with details projected inflows and

outflows during future periods Investing in assets worth exceeds their cost. Not a mechanistic process

A systematic approach to capital budgeting implies:

Formulation of long-term goals Creative search for and identification of new investment

opportunities Classification of projects and recognition of economically and/or statistically dependent proposals Estimation and forecasting of current and future cash flows A suitable administrative framework capable of transferring the required information to the decision level Controlling of expenditures and careful monitoring of crucial aspects of project execution A set of decision rules which can differentiate acceptable from unacceptable alternatives is required.

CAPITAL BUDGETING DECISION RULES

Three ranking methods:
Payback Period
Length of time required for net revenues to return the cost of investment

Discounted Cash Flow

Nett Present Value to create wealth by using existing and future resources to produce now and in the future with greater value than resource consumed.

CAPITAL BUDGETING DECISION RULES

Three ranking methods (contd):

Discounted Cash Flow

Internal Rate of Return is the rate of return which equates the anticipated net cash flows with the initial outlay

Investment
What is investment?
In finance, the purchase of a financial product or other item of value with an expectation of favourable future returns. In general terms, investment means the use money in the hope of making more money. In business, the purchase by a producer of a physical good, such as durable equipment or inventory, in the hope of improving future business.

Important of Investment
Vital to the success of a business. Not only brings capital, you can gain a variety of additional benefits.

Investment Decision Making

Investors should have a diverse investment strategies with the primary aim to achieve superior performance, which would also mean a higher rate of return on our investments. Investment strategies can be broadly classified under 4 approaches;
Fundamental approach - concerned with the intrinsic value of the investment instrument. Given below are the basic rules followed by the fundamental investor. There is an intrinsic value of a security, which in turn is dependent on the underlying economic factors. This intrinsic value can be ascertained by an in-depth analysis of the fundamental or economic factors related to an economy, industry and company. At any point in time, many securities have current market prices, which are different from their intrinsic values. However, sometime in the future the current market price would become the same as its intrinsic value. Inventors can achieve superior results by buying undervalued securities and selling overvalued securities.

Investment Decision Making

Psychological approach - The psychological investor would base his investment decision on the premise that stock prices are guided by emotions and not reason. This would imply that the stock prices are influenced by the prevalent mood of the investors. This mood would swing and oscillate between the two extremes of 'greed' and 'fear'. When 'greed' has the lead stock prices tend to achieve dizzy heights. And when 'fear' takes over stock prices get depressed to lower than lower levels. As psychic values seem to be more important than intrinsic values, it is suggested that it would be more profitable to analyze investor behaviour as the market is swept by optimism and pessimism. Which seem to alternate one after the other. This approach is also called 'Castle-in-the-air' theory. In this approach the investor uses some tools of technical analysis, with a view to study the internal market data, towards developing trading rules to make profits. In technical analysis the basic premise is that price movement of stocks have certain persistent and recurring patterns, which can be derived from market trading data. Technical analysts use many tools like bar charts, point and figure charts, moving average analysis, market breadth analysis amongst others.

Investment Decision Making

Academic approach - Academics have studied many aspects of the securities market and have developed advanced methods of analysis. The basic rules are: The stock markets are efficient and react rationally and fast to the information flow over time. So, the current market price would reflect its intrinsic value at all times. This would mean "Current market price = Intrinsic value". Stock prices behave in a random fashion and successive price changes are independent of each other. Thus, present price behavior can not predict future price behavior. In the securities market there is a positive and linear relationship between risk and return. That is the expected return from a security has a linear relationship with the systemic or non-diversifiable risk of the market.

Investment Decision Making

Eclectic approach - This approach draws upon all the 3 approaches

discussed above. The basic rules of this approach are: Fundamental analysis would help us in establishing standards and benchmarks. Technical analysis would help us gauge the current investor mood and the relative strength of demand and supply. The market is neither well ordered nor speculative. The market has imperfections, but reacts reasonably well to the flow of information. Although some securities would be mispriced, there is a positive correlation between risk and return.