This content introduces the crucial concept of investment appraisal within financial management, emphasizing its interconnectedness with financing and dividend decisions, and highlighting the importance of free cash flow for evaluating investment opportunities.
Mind Map
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We are moving to part B of the syllabus
and that is talking about investment appraisal.
appraisal.
Uh you recall that there are three core
decisions that a senior financial
executive must be able to take and there
we're talking about investment decision,
financing decision and dividend policy.
So we're taking the first one now which
is the investment decision.
You know what is all about investment
decision is you being able to select the
right investment for the company because
you want to maximize shareholders worth
and at the same time you want to achieve
the target which is the secondary
objective uh secondary financial
objective of every company. Yeah. But
before I go into the investment decision
itself, it's also good that I emphasize
on importance of knowing the linkages
between these three core decisions.
Remember we said you must be able to
make investment decision, financing
decision and dividend policy. So as we
as you move on in the study, you must be
able to understand how these three
decisions can be interlin.
Take for instance if you take investment
decision. Yes you want to pick the best
investment that will maximize return but
at the same time you have to finance
this investment. So financing is needed
to be able to do any investment because
if you don't have the fund you cannot do
the investment. Yeah. So and you must be
able to select the right financing
appropriate financing.
So which means your investment
can actually determine
the type of financing that you should be
talking about and how can investment
determine how they should be financed.
So what factors do you need to consider?
Yeah, how can investment determine the financing?
financing?
There are factors that you need to
consider. The first one is asking
yourself what is the nature of this investment
investment
because take for instance if the
investment has to be grain investment
which means net zero emission then you
want to match that investment with green
fund. So you can't just go to any bank
or go to any fund for investing. So you
should be matching this with green fund
because there are banks that would have
said they have dedicated fund for such
investment and you might be able to get
it at a cheaper rate right. So very
important to note that likewise apart
from the nature of the investment the
size of the investment also matters
because if you have a small size
investment then no problem you can
finance it internally with retain
earnings. You can even use credit line
maybe line of credit or something. But
if you are talking of large investment
then you might be talking of going to
even in stock market to raise fund
through public offer or you might be
selling bonds so that you can raise a
lot of money for such huge investment.
So apart from size as well the duration
of the investment also matters. If you
are talking of short-term investment,
you want to able to match it with
short-term funding. And if it's a
long-term investment, you want to match
with long-term funding. So, this is
about asset liability matching.
So, that can also influence what type of
investment you should be, what type of
funding you should be looking for. The
risk is also quite important because if
the investment is high risk, take for
instance, maybe you want to invest in a startup.
startup.
Yeah. Eg a startup business or maybe a
new product that has not been tested
before. So this is high risk investment.
This kind of investment you have to
match it with a funding that is less
risky. And the less risky funding for a
company is equity because when a company
finances his investment with equity, it
doesn't have any obligation to pay back.
So remember is the opposite from the
investor's part. For investor that is
why it is very risky. Equity is very
risky. So don't get it confused from the
company part. It is actually what they
want. They want a less risky investment
which is equity to finance high-risk
investment because it might not turn out
good. And with that case, they won't
have to worry too much about paying the
fund providers. But if there's a lowrisk investment,
