Question

What are some of the key factors affecting investment returns - internal characteristics and external forces.

Answer 1

The following factors would affect Investment Returns:

1. Interest Rates (External) - Interest Rates would affect the cost of capital that the company has to pay to use that money. For example, if a company starts a project that would take five years to complete. At the beginning of the project they borrow money at an interest rate of 4% per year. And the company expects to earn 6.5% on its investment over the life of the project. Over the next few years, if the interest rate falls to say 3%, it would make the project more profitable for the company but if the interest rate increases to 6%, then the project might even become unviable.

2. Economic Growth (External) - The overall growth rate of the economy is important because in times of higher growth consumers would be willing to spend more freely while in the times of lower growth or recession, consumers would be fearful and would want to save their money and postpone consumption. Thus, a lower growth rate or a negative growth rate could severely hamper a company's Investment Returns.

3. Availability of Finance (External) - Other than the cost of borrowing money, a company also has to consider that money might not be always available to be borrowed. For example, lets say a mining company is looking to borrow money to develop a new mine. But recently a few of their projects did not do as well as the company had planned. Or some of their competitors became bankrupt due to lower sales in the industry. In such a scenario, a lot of banks would be afraid to lend money to them as there is a risk of default.

4. Government Policies (External) - Government policies can have a major impact on the business of a company and can positively or negatively affect the Investment Returns. For example, the recent American tariffs imposed on Chinese products would have negatively affected the Chinese companies that used to export their goods to USA. The same tariffs would have felt like a blessing to another company in another country that might now be getting the orders that the Chinese company was getting earlier.

5. Strategy (Internal) - The decisions of the Management of a company regarding the business strategies will have an affect on the Investment Returns. For example, if a company wants to sell goods in America and wants to build a factory for the same. They could decide to build a factory in California or in Nevada and for deciding this they would consider factors such as availability of land, availability of skilled labor, potential tax benefits in each state, transportation cost to the get their goods out to the market, availability of the raw materials, etc.

6. Efficiency of the Company (Internal) - Once the strategic decisions have been made, the company needs to execute. And this requires the company to be efficient if it wants to maximize their Investment Returns. For example, if the company finalizes that the factory would be built in California and that it will take 2 years for the construction to be complete and that the cost of construction should be $20 million. Now if the company is able to finish the desired work within the given time-frame and given budget then it has a good chance of maximizing the Investment Returns. On the other hand, if the initial cost overshoots the budget, then the company would fail to maximize Investment Returns.

7. Competition (External) - The performance of the competition can have a huge effect on the Investment Returns of a company. Example: for a company manufacturing mobile phones, a successful new launch by a competitor can turn out to be catastrophic whereas the bankruptcy of a competitor could increase the Investment Returns.