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!