Making Investment Decisions - Rustica Industries - Case Study Example

Making Investment Decisions Name: Instructor: Institution: Course: Date: The investment decision is the determination by the management on where, how, when and how much capital will be spent and the debt to be acquired for the purpose of making profits. The investment decisions are contributed by several factors that include projects available, capital on hand, general market conditions and specific investment strategy. Before choosing which company to recommend for investment, Martin Smith should consider certain factors. First, he should determine the financial performance of the potential business investment. It involves identifying the profitability of the business and how it has been performing over the past years. It can be done by requesting for financial reports that consist of recent year’s tax and budget returns, current accounts receivable, projection of cash flows and their balance sheet. He should pay close attention to the balance sheet since it will give him a list of assets, liabilities and the capital in the business. Second, he should determine the market analysis that the company he wants to recommend for investment is involved. He can do this by studying and assessing the target customers and the marketplace before making the investment decision. He should also identify the competition status to determine whether the company is gaining market share. Third, Martin Smith needs to consider the amount of the investment by examining the operating capital and the credit needs of the company. It is important to reassess the current cash reserves, accounts payable and receivable, credit access and the cash flows to determine whether the funding is enough to sustain the company as a going concern (Korniotis and Kumar 2011). The type of private equity deal that will be conducted is acquisition. It is the process where one corporation purchases another. The acquisition agreement should be signed subject to satisfactory conditions. Martin Smith chose to recommend Rustica Industries for the investment due to a number of reasons. First, it is considered the largest manufacturer of industry wires and polymer storage systems in the US. It can create new products, and this enables it to meet the needs and demands of its target customers. Second, despite premium pricing, the financial position of the industry has significantly increased. It constitutes of 65% share of the industrial sales in the US, and it is six times larger than its competitor in the industry. Its net sales and earnings before interest, tax, depreciation and amortization have also been on an increasing trend for the last three years that is years 1990, 2000 and 2001. Third, its reputation has been established through manufacturing of quality and a wide range of products. It, therefore, has extended channels of distribution that enables it to serve a wide range of business segment. Fourth, the company has opportunities for cost reduction in manufacturing and distributing, incremental sales that will increase overall profitability and increase in penetration in the price sensitive markets due to low production cost. Fifth, the company has additional avenues for profit generation that include the foodservice division, healthcare division, commercial products division, consumer products division and international division. The foodservice division generates 41% of sales and 46% of earnings before interest, tax, depreciation and amortization. The healthcare division yields 17% of sales and 18% of earnings before interest, tax, depreciation and amortization. It focuses on developing products to meet specific healthcare needs of the customers (Koller, Goedhart and Wessels 2010). Despite the strengths, there are a number of limitations that should be a concern. First, Rustica Industries has low capacity utilization. This is the extent to which the productive capacity of a firm is used in generating goods and services. The capacity utilization level of a firm determines the allocation of fixed costs per unit. There is therefore reduced profitability as a result of increased prices. Second, the industries have relative market saturation. It is the point at which the industry is not generating new demands for the products. Rustica Industries need to take action to generate further sales and profits. It will bring a change in the market strategy to generate additional demands in the industry. Third, Martin Smith was concerned that Rustica Industries have low barriers to entry. The risk of entry into the industry reduces and that makes the industry be crowded and this increases competition. Rustica Industries is therefore not able to improve operational efficiency because of competition (Koller, Goedhart and Wessels 2010). Every investment opportunity has a percentage of risk and uncertainties that differs concerning the type and geographical location of the investment. The risks and uncertainties in investment lead to an increase in the separation between the marginal product of capital that justifies disinvestment and the one that justifies positive investment decisions. They are significant components that are due to limited knowledge of current conditions and future outcomes. They are caused by proximity that explains that the things that are bound to happen are easy to predict and handle as compared to those that are further and unknown in the future. When preparing the presentation at the partners’ meeting, Martin Smith should highlight several risks and uncertainties that are involved in the investment. First, he should focus on the effects of technology change on the investment. Technology is changing as time goes, and this can affect how a business conducts its activities. In order to ensure the success of the investment, the managers of Rustica Industries need to stay informed of affirmative technologies and make relevant decisions about those to implement in the running of their industries. Second, it will be important to determine the risk of uncertainty in the interest rate that will be involved. Investing in Rustica Industries will be determined by the interest rates of investment. If the interest rates are high, the partners should consider not investing in Rustica Industries. The uncertainty will be derived from the volatility of the yields and the microeconomic variables. Third, the risk and uncertainty of inflation should also be considered. It hinders the decision-making of businesses and reduces the well-being of the economy. If the partners choose to invest in Rustica Industries, they will be faced with this uncertainty that is a global effect (Arrow and Lind 2014). Fourth is the default risk that is as a result of lack of payment. When Newport partners decide to invest in Rustica Industries, they face this default risk in that they might not receive their capital invested or the generated profits from this investment. Default may be caused by a number of factors that include weakness in the administration of funds or problems of moral hazards. To deal with the risk, Newport partners should seek support from government and enhance post-disbursement monitoring systems to ensure the safety of their investment and returns. Fifth, business risks need also to be considered. The market value of an investment depends on the company’s performance. If Rustica Industries do not perform well, the investment of Newport partners will be affected negatively. Sixth, Martin Smith should also outline the liquidity risks that are involved with the business that the Newport partners want to invest. Liquidity is the ability to convert assets or investment to cash. Liquidity risk is the possibility that investors might not be able to realize the value of the investment when required. It may be as a result of securities not being sold in the market or have been terminated pre-maturely. Seventh, he needs to consider the political risks. They occur as a result of powers exerted by the government in the market. They include the threat of war and fixing ceilings of the property. The Threat of war becomes a risk to the investment market. When the government fixes ceilings, the investments cannot maximize the profits (Bakke and Whited 2010). There are a number of issues related to the valuation of the investment that Newport partners need to consider. First, they need to take into account the illiquidity discounts. They will incur trading costs when they decide to terminate the investment. This illiquidity costs should be taken into account. Second, if Newport partners decide to acquire the Rustica Industries, they need to take into consideration the value of the control. They should be willing to pay equity premium of the takeover for them to gain control of the industries (Hitchner 2011). Third, they need to determine the fair value of the portfolio investment. Dilution of investment can occur if Newport partners do not value it. The operations of carrying through with the investment decision have several organisation issues. First, they are faced with team problems. Teams need to be committed and dedicated to the business to yield high performance. Personal disconnection will lead to non-functionality of the business. Second, the employee issues can affect the performance of the partnership. The problems of an individual employee can conflict with the organisation, and this can only be solved by effective communication. Third are the ethical issues in the organisation. There should be shaping of finances and funding opportunities in the management of the investment (Bonini, Shoup and Zan, 2013). The Newport partnership is faced with challenges and disadvantages. First, in partnership, the liability for the debts and the acts of the partnership is limited. If the business becomes insolvent and indebted, the personal assets of the partners will be sold to pay up the debts. Second, there is unclear authority among the partners. There is vagueness in outlining the responsibilities that each partner is entitled to carry out. This is the resource problem that Newport partnership is encountering, and it might affect their investment decision. Third, there is the risk of disagreement from the partners (Koller, Goedhart and Wessels 2010). This arises when the partners lack common understanding over operational and financial decisions. Failure to resolve the disputes can lead to the dissolution of the partnership. Fourth, when the partners leave or join the partnership, the assets have to be valued. This valuing is costly and time wasting. Conclusion Investing in Rustica Industries by Newport Partners will be advantageous as compared to other selected industries. The investment performance will be determined by valuation strategies, organisational issues and the risks and uncertainties. The industry’s knowledge will guide the investors to determine its potential. The aim of Newport partners in investing in the industry is to maximise profits and returns. Most of the strategic investment decisions have ill-structured problems and this calls for approaches that will help solve them. Project ranking plays an important role in determining the investment project. It is important to determine the effects that the industry’s failure will have on the finances of the investors. This will help to well manage the investment in order to protect the personal finances. References Arrow, K. J., & Lind, R. C. (2014). Uncertainty and the evaluation of public investment decisions. Journal of Natural Resources Policy Research, 6(1), 29-44. Bakke, T. E., & Whited, T. M. (2010). Which firms follow the market? An analysis of corporate investment decisions. Review of Financial Studies, hhp115. Bazerman, M., & Moore, D. A. (2012). Judgment in managerial decision making. Bonini Baraldi, S., Shoup, D., & Zan, L. (2013). Understanding cultural heritage in Turkey: institutional context and organisational Issues.International journal of heritage studies, 19(7), 728-748. Hitchner, J. R. (2011). Financial valuation: applications and models (Vol. 545). John Wiley & Sons. Koller, T., Goedhart, M., & Wessels, D. (2010). Valuation: measuring and managing the value of companies (Vol. 499). John Wiley and Sons. Korniotis, G. M., & Kumar, A. (2011). Do older investors make better investment decisions?. The Review of Economics and Statistics, 93(1), 244-265. Read More