Reverse Mergers
The profession of investment banking has become quite innovative over the years. Traditionally, raising capital was an expensive as well as time-consuming process. However, over the past few years, investment banks have devised ways to help their clients raise funds. These ways are neither time consuming nor expensive. A reverse merger is one such innovative […]
Private Equity Investments in the Sports World
Sporting franchises across the world have traditionally been owned by wealthy individuals. This has largely been because of the fact that sporting franchises have been viewed less as financially viable investments and more as vanity toys. However, all this has started changing in the wake of stellar returns provided by sporting franchises in the recent […]
The Design of the Central Bank
The banking system is an integral part of the financial system of many countries. In fact, as we have discussed in the previous articles, many countries base their entire financial system on the banking system. The central bank plays a very important role in the financial system of any country. This is the reason why […]
Framing Bias
Traditional economic theory assumes that investors are completely rational beings. Hence, they react to information in the same way if the content of the information is the same. However, behavioral finance theory seems to disagree with this assumption. According to them, investors interpret information in different ways if it is presented to them differently. This […]
Aspiring for a Career in Finance? Here are Some Things that Would Help You Prepare
The Glitz and Glamour of Finance Beckons Many Many management graduates and those working towards entering business schools often aspire to be financial professionals and dream of being an investment banker, private equity specialist, stock analyst, or a pure play banker in the plain vanilla banking. Indeed, with the globalization of finance and the integration […]
From the past few articles, it may seem like capital budgeting has a pre-determined procedure. All the possible scenarios that can occur have been thought of and appropriate solutions for all of them have already been developed. While this makes “capital budgeting” a good subject, it also removes the creativity from it. There is a general perception that jobs pertaining to finance and capital budgeting are boring and lack creative potential. As we shall see in this article, this is definitely not the case. The subject does provide room for ample creativity. Here are some examples:
Our NPV rule says that if a project has a positive NPV, it is financially viable. The NPV rule does not say that the project needs to be undertaken immediately. As many creative professionals have shown before, the NPV of a project can be magnified just by waiting for sometime before you execute it.
Consider the case of a building construction. You have conducted your analysis and it shows that given the cash inflows and outflows listed on your schedule, the project is a good bet. Does that mean you should execute it immediately? Well, this wouldn’t be the case if you found out additional information.
What if you found out that the government was about to declare an area near your proposed building site to be a “tax-free zone” for corporations. You would obviously expect a lot of companies to set up their shop there and this would increase the property prices, isn’t it?
Also, what if you find out that the government is about to create an underground train line linking that area to the centre of the city. Now, obviously it would make sense to wait, right? The NPV of the project is positive now. But it will be many times larger, if we waited for some more time. (Assuming that the information is credible)
So, a positive NPV does not mean that the project should be executed immediately. Any project always has two implicit options. One is to execute it right away and the other is to execute it at a later date. Many times projects with negative NPV turn around positive in a few years. The real task of the financial manager therefore is to be aware of this information that could affect their project and look into the future. What is in the present can be easily seen and discounted even by a computer!
Many times companies are faced with this decision regarding whether or not they must re-engineer the way in which they operate. This may include shutting down for a few days and then re-opening with completely different equipment, processes etc. These projects are usually viewed by financial managers as an all or nothing game. They will calculate the NPV for the entire project as a whole before they make a decision.
Now, creative financial managers on the other hand realize that it doesn’t have to be an all or nothing game. They pick and choose parts of the project and work out with combinations. They will try and find out if it is in the best interest to execute the entire project now or would executing 25% at a time for the next 4 years lead to a higher NPV.
The real point here is that the goal is to maximize the NPV. There will be given scenarios which are known to everyone. The trick is to think about the project in terms of time, partial implementation etc which are not the scenarios people would commonly think of. Like in all other professions, a good financial manager is a creative financial manager. He/she will find ways and means of maximizing the NPV.
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