Understanding Business Investments

• Investment is an expense made by a business in a specific project, such as commerce, industry, or service, with the goal of generating future income.

Types of Investments

• Investment can be defined by its nature or fuction.

Function

• Renewal Investment: Involves replacing outdated production methods.
• Productivity Investment: Aims to increase the company's production capacity.
• Diversification Investment: Involves investing in new machinery to diversify the company's products and enter new markets.

Nature

• Investments are subdivided into 3 parts
• Intangible Investment: Acquiring intangible assets.
• Tangible Investment: Acquiring tangible assets.
• Financial Investment: Acquiring stocks in the financial market.

Net Cash Flows

• Net cash flows are divided into two categories: expenditures and resources.

Resources

• The total cash inflows received by the company throughout the project's duration.
• CAF (Capacity for Self-Financing): Corresponds to the potential resources obtained by the company.
  • CAF = Net Profit + Depreciation Expense
  • CAF = EBE - Corporate Tax
• Net Residual Value: Obtained from the sale of assets used during the project.
  • VRN = Selling Price + (30% * Loss)
  • VRN = Selling Price - (30% * Gain)
  • Application Example:
    • Asset purchased for 10,000,000 with accumulated depreciation of 6,000,000 and sold for 5,000,000.
    • Net Book Value (NBV) = Acquisition Price - Accumulated Depreciation
    • NBV = 10,000,000 - 6,000,000 = 4,000,000
    • Gain = Selling Price - NBV
    • Gain = 5,000,000 - 4,000,000 = 1,000,000
    • VRN = 5,000,000 - (0.3 * 1,000,000) = 4,700,000

Recovery of Working Capital Needs

• Working capital requirement addresses time differences between collecting receivables, managing inventory, and making payments to suppliers.
• At the end of the project, the working capital need is zero because all receivables are collected, stocks are sold, and debts are paid. It is often expressed in 'x' days of turnover.

Expenditures

• Acquisition Cost: Includes all expenses incurred by the company from the date of acquisition until the asset is put into use.
  • Acquisition Price = Purchase Price + Customs Duty + Transit + Transfer Duty + Non-Recoverable VAT
• Variation in Working Capital Needs: Represents a cash requirement for the company.
  • Year 0: Working Capital Need = A
  • Year 1: Working Capital Need = A, Variation = B-A
  • Year 2: Working Capital Need = B, Variation = C-B

Investment Choice Criteria

• Two key elements are essential to measure a project's profitability:

Duration

• Refers to the expected life of the investments
• It is often based on the DUP (Duration Until Payback) of the investment.

Rate

• Refers to the rate of return that equates the present value of future cash flows with the initial investment.
• It typically corresponds to the bank interest rate applied by the BCEAO or the average bank interest rate.

Presentation of Net Cash Flow Table

• Elements of Project Analysis
  • Revenue
  • Variable Costs
  • Contribution Margin (Revenue - Variable costs)
  • Fixed Costs
  • Earnings
  • Corporate Taxes
  • Net Profit
  • Depreciation Expense
  • Capacity for Self-Financing (CAF)
  • Residual Value
  • BFE Considerations
  • Available Resources (1)
  • Acquisition Cost
  • Change in BFE
  • Expenditures (II)
  • Net Cash Flow (I - II)

Measuring a project's profitability

• The manager can use one of the following four criteria:
  • Net Present Value (NPV): The sum of the discounted net cash flows minus the cost of investment. It is the profit that is expected by the investors.
  • NPV = Net Cash Flows - Investment Cost
  • NPV = - Initial Investment + Σ CFt / (1 + r)^t
    • NPV > 0: Project is profitable
    • NPV = 0: Project is profitable
    • NPV < 0: Project is not profitable
• Internal Rate of Return (IRR): The discount rate that makes the NPV of all cash flows from a particular project equal to zero.
  • If IRR > Required Rate of Return: The project is profitable
  • If IRR = Required Rate of Return: The project is null
  • If IRR < Required Rate of Return: The project is not profitable
  • It is obtained through the linear interpolation method:
    • t1 => NPV1
    • IRR => NPV = 0
    • t2 => NPV2
    • IRR = t1 + (t2 - t1) * (NPV1 / (NPV2 + NPV1))
• Profitability Index (PI): Measures the relationship between the costs and benefits of a proposed project.
  • PI = (NPV / Initial Investment) + 1
  • PI = (Σ CFt / (1+r)^t) / Initial Investment
    • If PI > 1 => Project is Profitable
    • If PI = 1 => Project is Null
    • If PI < 1 => Project is Not Profitable
• Payback Period: Indicates the time required to recover the funds invested in a project
  • DRCI = Cumlative date inferior + (Io-Cumulinférieure/Cumulative superior -Cumulative inferior)
    • If DRCI > Project Lifetime => Project is Profitable
    • If DRCI < Project Lifetime => Project is non-profitable