Risk Analysis on Investment Decisions

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Risk Analysis on Investment Decisions Investment techniques used in corporate finance when making decisions on projects usually focuses on cash flows of the firm (Ross, Westerfield, and Jaffe, 2004). Because of drastic changes in the business environment over the last decade, managers are requesting better, more accurate information, and improved techniques to meet company needs for making major decisions with data consisting of clear goals, a planned design, high ethics, revealed limitations, adequate analysis, and justified conclusions (Cooper and Schindler, 2003). In this paper, the methods of net present value and internal rate of return are examined based on real-world capital budgeting decisions. This paper also gives insight on…show more content…
The choice between the methods does not affect after-tax cash flows of the firms. "The difference between the value of the combined firm and the sum of the values of the firms as separate entities is the synergy from the acquisition" (Ross, Westerfield, and Jaffe, 2004, p. 802). The acquiring firm generally pays a premium for the acquired firm. One reason for acquisition of another company is that a combined firm generates greater revenues. Increased revenues may come from marketing gains, strategic benefits, and market power. Mergers and acquisitions produce greater operating revenues through improved marketing and the shareholders of the acquiring firm will gain if the synergy from the merger is greater than the premium (Ross, Westerfield, and Jaffe, 2004). Benefits of an acquisition derive from revenue enhancement, cost reduction, lower taxes, and lower cost of capital.
Risks Associated with Investment Decisions
Capital budgeting must be placed on an incremental basis, ignoring sunk costs and considering both opportunity costs and side effects. As the company expands, working capital rises over the early part of the project, with all working capital recovered at the end of the project. All inventories is sold by the end of the project, the cash balance is liquidated, and all accounts receivable are collected, generating cash from other sources in the company, hence cash outflows. If working capital is at a high level, there will be no cash outflow over
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