Investment for a Business - Investment Appraisal Techniques and Potential Success of the Venture - Example

Create an investment proposal for a business of your choice Contents Contents 2 Introduction 3 Discussion 3 a. Sources of Finance 3 b. Investment Appraisal Techniques 4 c. Potential Success of the Venture 5 d. Financial Documentation 7 7 Conclusion 9 References 11 Introduction XYZ Consulting is intended to be formed as an organization which focuses on sales and marketing of high technology products across international markets. The founders of the company have worked as marketers of personal computers, consulting services, and market research in the past. Their sole intention to form XYZ Consulting is to formalize the services that they offer. The company offers manufacturers of high tech products with an alternative to substitute their in-house resources for market development, business development, and also channel development. The company has the expertise to develop new segments and new product distribution for high technology organizations in emerging and new markets. This can take various forms such as reports on market research; project based consulting, and retainer consulting. The challenge for the company is to establish itself as a consulting company that is recognized by everyone. There are numerous forms of industry competition for the company XYZ Consulting. In this regard the competitors for the company could be those organizations that choose to do market research and business development in-house. There are also renowned consulting firms in the market such as Boston Consulting and Arthur Anderson. XYZ Consulting has to provide quality consulting in this regard to facilitate integration of market research data with the goals of the organization. Discussion a. Sources of Finance The two main sources of financing are considered to be equity and debt form of financing. Equity financing refers to sharing of ownership by an organization for financial investment in a particular business. Equity shareholders are the owners of the company and as such they get a share of the company’s profits. Equity investments are considered to be long term sources of finance for a company. Debt financing involves borrowing funds from investors at a fixed rate of interest. The use of debt by an organization to finance its activities can be considered to be a little risky (Cuthbertson and Nitzsche, 2008, p. 64). This is so because for a start-up organization like XYZ Consulting it may be difficult to earn considerable revenues to meet the cost of debt in the initial stages of its existence. If the organization is not able to earn much revenue, it may be difficult for the company to meet its interest costs with regard to debt. Debt form of financing is advantageous for an organization when its earnings are considered to be very huge to meet its interest expenses with regard to debt. In that regard it can be said that earnings of shareholders get increased to a considerable extent because of the favourable use of debt by an organization. Venture capital financing can also be considered by the company XYZ Consulting as a means to finance its activities in the initial stages of its existence. As the organization has not become a renowned name and that it is a start-up company in the market, it may face difficulties in equity form of financing. Investors may be apprehensive of the fact of investing in a start-up company like XYZ Consulting. So under such circumstances, venture capital can be considered as an important source of financing by the organization. Venture capital is usually provided to start-up companies to fund their activities in their initial stages when procurement of capital is difficult for such companies. The providers of such capital usually expect a high rate of return solely because of the risk factor that is associated with such form of financing. b. Investment Appraisal Techniques Net Present Value (NPV) is considered to be an important investment analysis technique in the modern world. It can be considered as the difference between projected future inflows and projected future outflows discounted by the company’s cost of capital. In other words, it is considered as the present value of the difference between future inflows and future outflows. NPV is considered very important as it measures the profitability of an investment. It takes into account all the cash flows that occur over the life of the project and hence measures its true worth. It also considers the time value of money in the process. The higher the net present value, the better it is for an organization (Bodie, Kane and Marcus, 2008, p. 52). If NPV is found to be less than or equal to zero, the project should be rejected by the company. If it is found to be more than zero, the project should be accepted as it has the potential to make profits in the future. Investors who are thinking of investing in the company XYZ Consulting would like to have a look at the NPV of the projects that the company XYZ Consulting is going to undertake. It will give them an idea about the profitability of their investments. Internal Rate of Return (IRR) is also an important tool in this regard to measure the profitability of investments. It is considered as that discount rate which equates the projected capital outlays to the present value of expected future earnings by an organization. It is considered as that rate of return which makes the NPV equal to zero. It is sometimes also called as Economic Rate of Return (Van Horne, 2001, p. 74). It can be termed as the breakeven point with respect to cost of capital of an organization. Internal Rate of Return denotes the liability of investments with respect to the rate of return that is expected by investors. IRR has gained a wide acceptance because of factors such as it is easy to understand, adjusts for risk, consideration for time value of money, and is also a measure for profitability. It is widely recognized that the greater the internal rate of return for a company, the more attractive it is for the investors. c. Potential Success of the Venture XYZ Consulting follows a conservative approach with regard to its financial plan. The company has conservative assumptions and estimates. The plan of the company is to focus on its initial investment to make its financials work. It plans to maintain an average collection period of 45 days and also average payables period at 35 days. The sales of the company would be totally on invoice basis. The pricing strategy of XYZ Consulting will fit the general positioning of the organization as a provider of high quality expertise. Project consulting charges of XYZ Consulting could be £ 6500 per day, £ 3000 for market research per day, and £ 15000 per month or above for retainer consulting. The reports on market research should be priced at £ 7000 per report by the company XYZ Consulting. The practice of capital budgeting by any company has become very important considering undertaking an investment. The decisions with regard to capital budgeting are of immense importance that shape the future of an organization. The capital budgeting decisions of XYZ Consulting should have a link with the strategic plan of the organization. The company in this regard should take sound decisions regarding selection of investment projects that result in maximization of wealth of shareholders. The selections of the most profitable investments are done by the use of various techniques such as Internal Rate of Return (IRR), Net Present value (NPV), Payback Period, Profitability Index and Discounted Payback Period. The process of capital budgeting will give the company XYZ Consulting a guideline regarding the acceptance of projects. It will also help the company in determining the amount of capital expenditure that the company may have to undertake in the future. The process of capital budgeting is a crucial factor which determines the success of any organization. Capital investments tend to be very huge for an organization. These investments also influence the future cash flows of any organization. So it is of utmost importance that organizations manage these decisions in an efficient manner because any failure in this regard will result in the company suffering huge financial losses in the long run. Sound capital budgeting decisions help an organization to build goodwill among investors. If the company accepts only those projects that are hugely profitable, the wealth of shareholders will be maximized to a great extent (Maude, 2006, p. 41). As a result, the trust of the company among general investors will be established in a great manner. Investors will then find it highly rewarding to invest in the company XYZ Consulting because it will fetch them a high rate of return on their investments. Moreover capital budgeting decisions are very difficult to reverse for an organization as it involves a huge amount of cost. The funds are tied up for a very long time because capital budgeting decisions are usually made for the long term horizon. Due to these reasons, it is very important that organizations employ appropriate techniques to analyze the profitability of their projects. d. Financial Documentation The projected sales for the company are considered to be quite high at £ 1200000. The direct cost of sales is also very low for the company. It implies that the efficiency of the company is very high with regard to generating profits. The company XYZ Consulting has also very low indirect expenses as compared to its revenue generation capability from consulting services. The company has a very high projected operating profit from its operating activities. But the interest cost is a little bit high for the company. In this regard, it has to make sure that it makes consistent profits to meet its debt cost. The favourable use of debt capital by the company can only be achieved if it is able to make consistent profits in the long run.  Projected Balance Sheet 2014 Assets Current Assets: Cash £ 50000 Accounts receivable £ 100000 Other current assets £ 25000 Total current assets £ 175000 Long term assets: Long term assets £ 650000 Accumulated depreciation £ 0 Total long term assets £ 650000 Total Assets £ 825000 Liabilities and Capital Accounts Payable £ 30000 Short term borrowings £ 50000 Other Current Liabilities £ 0 Total Current Liabilities £ 80000 Long term liabilities £ 20000 Total Liabilities £ 100000 Paid-in Capital £ 50000 Earnings £ 625000 Total Capital £ 725000 Total Liabilities and Capital £ 825000 Net Worth £ 725000  The position of the company as portrayed in the projected balance sheet is also quite satisfactory. The projected net worth of the company is quite high. The company has earnings of £ 625000 which only implies the profitability of the company. Projected Cash Budget 2014 Opening cash balance £ 10000 cash from operations £ 200000 Total available cash £ 210000 Less: Capital expenditures £ 160000 Interest £ 20000 Dividends £ 100000 Total disbursements £ 280000 Add: Short term loans £ 50000 Capital issues £ 50000 Long term loans £ 20000 Ending cash balance £ 50000 The company has generated a satisfactory level of cash from operations. The liquidity position of the company is also considered satisfactory as portrayed by the projected cash budget. Conclusion The company XYZ Consulting is intended to be formed as an organization which focuses on sales and marketing of high technology products across international markets. The company offers manufacturers of high tech products with an alternative to substitute their in-house resources for market development, business development, and also channel development. The company intends to specialize in project based consulting and retainer consulting. The challenge for the company is to establish itself as a leading company in this field. There are also renowned consulting firms in the market such as Boston Consulting and Arthur Anderson which can give the company XYZ Consulting a tremendous competition in this regard. The company has to resist many forms of industry competition to establish itself as a leading company in this field. The company XYZ Consulting has the required competency to succeed in this regard. It has to make sure that the competency that the company has in this regard is best utilised to gain competitive advantage over its competitors. References Bodie, Z., Kane, A. and Marcus, A.J., 2008. Investments, 7th ed. New York: McGraw-Hill. Cuthbertson, K. and Nitzsche, D., 2008. Investments, 2nd ed. New York: Wiley. Maude D., 2006. Global Private Banking and Wealth Management. New York: John Wiley & Sons. Van Horne J.C., 2001. Financial Market Rates and Flows, 6th edition, New York: Prentice Hall. Read More