Investment Appraisal and Risk Analysis

The society at large more or less dwells on the perception of having investments just to make good returns, either for profit maximisation or shareholder wealth maximisation depending on the focus of the firm itself.

The issue of investment has a much larger scope than anticipated, for instance not only do we have the basic knowledge of investment; which is present to give us a profit or some kind of an advantage (as stated in lectures), but also in deeper terms, investments involve a lot of calculative estimates to allow further planning which will determine whether or not a project investment is carried out.

There are several ways of investment appraisals which will determine the initial investment and the estimated costs (variable and cost of capital) involved for any project. The methods used to make such calculations include NPV, Payback Period, ARR and IRR. All these methods have different outcomes but only two (NPV and IRR) of them consider the ‘Time Value of Money’ as well as the idea of ‘shareholder wealth maximisation’ for NPV, and these two are much more complicated to calculate unlike the other two methods (ARR and Payback Period). Either way these methods provide different outcomes and depending on the outcome they give or show of a higher profit, will end up being the chosen method for a project, but not with-holding the fact that for a project to be fully considered, risks assessments also have to be acknowledged and taken into account.

Investments risks are such that unforeseen circumstances or events may occur so in order to make better projections for future projects, risks have to be considered by making calculations for risks allowance in the estimated budgets. Businesses nowadays conform to either of the three (Sensitivity analysis, Scenario analysis and Profitability analysis) analysis to judge the financial risks involved in the world in general. In some cases risk allowances can easily be made except in the instance of natural disasters etc; there are some events that even with risk analysis it was not enough to resolve the issue. Such issues include the current financial climate of what we now know as the ‘credit crunch’ (though not a natural disaster but even the risk analysis could not justify this crisis caused by the US economy which we’re all still paying for worldwide) as well as the most recent natural disaster event that is currently on the news and has once again shaken up the financial economy which is the Japan earthquake and Tsunami. The Japan crisis has caused a lot of more uncertainties especially with the added crisis of the nuclear plant that blew up.

Certainly no matter how much estimated projections can be made by management in terms of plans to carry out projects, it is my belief that investment appraisals and risks analysis is just not enough to make a satisfied judgement on projects, considering the occurrences of natural disasters e.g. the Tsunami, Nuclear explosions and even the war currently taking place in Libya. Businesses or projects are just a ‘give and take’ in terms of risks and investments, its either you’re in or you’re out!     

Aftermath of the credit crisis- Lehman Brothers

The credit  crunch has not only occurred once but twice. The first being in 1929 followed by the Wall Street crash in 1928. The second occurrence on the 'credit crunch' was said to have begun in August 2007 although there are still some arguments to suggest otherwise. Nontheless the credit crunch began as a result of money shortages where banks were not willing to lend to any other banks. This then led to a high on the amount of Mergers & Aquisitions (M&A) considering some companies were no longer able to survive alone and needed another to depend on hence the mergers and takeovers.

One of the first major US bank that was allowed to collapse without any assistance from the US Federal Reserve was the 'Lehman Brothers'. Being a huge financial provider/lender it was a huge and yet negative news when they announced of their of approximately $3.9bn in early September and just a couple of days after the that announment, they decided to file for 'chapter 11' bankruptcy protection in September 2008. After this event, the banking industry began going downhill as the banking system was being demolished, this definately had an adverse effect on the banking industry globally as a whole.

Looking at the effects of the credit crunch today (four years later) especially in the case of the Lehman Brothers the financial economy is still upon the verge of a rival from the recession, and the famous Lehman Brothers just before their announcement of bankruptcy they deposited an amount of $2bn with Citibank in June 2008 which they are trying to recover from current legal proceedings. One of the current issues on the business news lately was that the Lehman Brothers have appointed their trustee (James Giddens) to carry on the legal proceedings against Citibank for not returning the $1bn deposit given to them for foreign exchange settlement services. So now the trustee is sueing them and seeking $1.3bn for the Lehman Brothers' creditors. Citi group on the other hand are stating their refusal towards this matter and classifying the matter as an 'unjustified claim'.

I think that the decision Lehman Brothers did so secure their $2bn deposit with Citibank was a wise idea considering they later filed for chapter 11 bankruptcy as the US Federal Reserve refused to bail them out financial. So really even though they owed a few millions to Citibank that did not mean it was within the right of Citibank to keep hold of that deposited money and say they used it to cover up the debts and costs they were owed by the Lehman Brothers. Surely even in the court this idea would have to be considered as am sure a contract of some kind was signed prior to the filing of bankruptcy. So what will the future hold for other companies that were affected by the 'credit crunch'.

Are mergers always good or bad?: why merge?

The main aim of a business who has investors such as that of 'shareholders' is to increase shareholder wealth so in the case of mergers and aquisitions, i would expect this theory to remain a top priority for the merged companies.

Though mergers are suppose to benefit both shareholders and the organisation as a whole in both companies i believe this depends on how successful or unsuccessful the takeover is for the target and bidding company as described in a survey by Jensoon and Ruback (1983) on US firms.

Mergers and aquisitions are actually risks due to uncertainties, because no matter what the figures may represent, one cannot always tell the outcome of a takeover until after a few months or years. This will inturn be reflected in the joint company figures as well as that of the dividends (if any) for shareholders. There are a few reasons which have been highlighted by a survey by Coopers and Lybrand, which state the possible reasons behind a merger failure and a merger success. The reasons they highlighted made alot of sense and in the case of why mergers fail; i think the reasons given are something that can be seen as 'common-sense' by companies which should be avoided before embarking on a takeover or any joint venture.

Mergers are always meant for good but there are different motives as to why a firm would merge. For some it maybe for synergy, bargain buying, managerial motives, but i think most would merge because of 'market power' as this will enable a firm more sector control and global integration. Companies that plan to be successful after M&A, would have previously outlines a clear purpose for their actions, and would have analysed both company cultures as well as possible gains in order to ensure the success of their M&A.

Earlier in the week was the news of a merger between DemandTec to aquire M-Factor, which took place on March 9th 2011. M-Factor provides predictive analytics software for marketing and trade whilst DemandTec specialises in connecting retailers and consumer products companies. Together the companies are hoping to collaborate and produce a hightech "science-driven framework for optimising marketing mix ...". Prior to the aquisition the firms highlighted the gains of their current aquisition, this meaning they might have followed the 'reasons for success of M&A' as described by Cooper and Lybrand. Altogether their reasons of this aquisition i think is an opportunity for grwoth and integration, but the success of these two companies will depend on the company cultures and how well they operate within their sector for a competitive advantage before they would even think of obtaining 'market power'. But again only time will define the success of this aquisition, for now all looks 'bright and beautiful'.

China opportunities - Tesco's International Strategy

With the current manufacturing boom in China, it has now become the land of opportunities for many international investors around the world. I mean with room for cheaper labour and ability to for international companies to set up their manufacturing departments in such a land, what else can be more lucrative for organisations than to try and cut costs and aim at making thier shareholders happy due to the possibilies of higher profits.

Such thoughts might just have been what was going through the minds of the Tesco executives when they decided to invest in Asia especially China and Korea where they saw a more 'foreseeable future' in terms of not just international growth but overall growth for its organisation. At the moment Tesco's biggest competitor is Sainsburys with a current-year earnings multiple of 14.6 and Tesco's current-year earnings multiple being just 12.9 times. This is definately far less than sainsbury's but with Tesco investing in developing countries such as China and other Asian countries (as well as the Tesco banking group) this has given them some kind of competitive advantage over their competitors one way or another.

Currently Korea is Tesco's number two best seller, and part of the reason for this is due to the strategies (skills, resources, experience) that have been implemented which will be deployed to their stores in China. As one can see Tesco are using the 'Foreign Direct Investment' (FDI) method to their advantage as they use this power to exploit new markets in countries that have future prospects. With FDI i think Tesco has made the right moves as tax in Asian countries are cheaper than that of the UK plus there is rapid technology change happening in Asia faster than anywhere else in the world meaning one can implement technical changes into the Tesco operations much quicker and cheaper again giving them more competitive advantage over their competitors. Personally not only is FDI beneficial to Tesco but also to its host countries in Asia as it allows them to benefit from global growth hence increase their economical growth. With better infrastructure, low tax, cheaper labour, better currency exchange, who would not want to exploit the great opportunities of Asia especially China being one of the largest economies of the world?! The future is bright, the future is Asia.