Investment Terminology (For IPCC/PCC Students)
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Introduction
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This article will deal with various terms related to Investment.
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There are some basic things which we analyze before investing in any Co. To analyze such things we need complete clarity about them .
- I will try to give a brief idea about such terms and necessary formulae (wherever possible ) along with market standard and latest trends.
Basic terms related with investments
(A) Return On Investment ( ROI ):- I have added point 4 and 5 from an investment website to explain this topic more clearly .
- It is basically a performance measure which is used to evaluate the efficiency of an investment.
- ROI analysis compares the magnitude and timing of investment gains directly with the magnitude and timing of investment costs.
- A high ROI means that investment gains compare favorably to investment costs.
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Simple ROI for Cash Flow and Investment Analysis (Source- internet)
Return on investment is frequently derived as the “return” (incremental gain) from an action divided by the cost of that action. That is “simple ROI,” as used in business case analysis and other forms of cash flow analysis. For example, what is the ROI for a new marketing program that is expected to cost $500,000 over the next five years and deliver an additional $700,000 in increased profits during the same time?
5. Consider two five-year investments competing for funding, Investment A and Investment B. Which is the better business decision? Analysts will look first at the net cash flow streams from each investment. The net cash flow data and comparison graph appear below.
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Now | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Total |
|---|---|---|---|---|---|---|---|
| Net Cash Flow A | –100 | 20 | 30 | 40 | 70 | 80 | 140 |
| Net Cash Flow B | –100 | 70 | 60 | 40 | 30 | 20 | 120 |
Two aspects of the data are apparent at once: (1) Investment A has the greater overall net cash flow for the five year period, but (2) the timing of cash flows in each case is quite different. The differences in timing are even more apparent in a graphical representation of net cash flow:
To answer the question, "Which is the better business decision for the company?" the analyst will want to examine both investments with several financial metrics, including ROI, NPV, IRR, and Payback period.
In order to calculate ROI, the analyst needs to see both cash inflows and outflows for each period (year) as well as the net cash flow. The tables below show these figures for each investment, including also cumulative cash flow and Simple ROI for the investment at the end of each year.
| Investment A | Now | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Total |
|---|---|---|---|---|---|---|---|
| Cash Inflows A | 0 | 40 | 50 | 75 | 95 | 105 | 355 |
| Cash Outflows A | 100 | 20 | 20 | 35 | 25 | 25 | 225 |
| Net Cash Flow A | –100 | 20 | 30 | 40 | 70 | 80 | 140 |
| Cumulative CF A | –100 | –80 | –50 | –10 | 60 | 140 |
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| Simple ROI A | -100.0% | –66.7% | –35.7% | –5.7% | 30.0% | 62.2% |
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For Investment B...
| Investment B | Now | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Total |
|---|---|---|---|---|---|---|---|
| Cash Inflows B | 0 | Category : Finance |
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