Question

As a senior manager, recommend the key financial issues you would consider before making a decision about a significant financial commitment to a new investment project in your business. You are to assume that the project has been developed by managers who report to you, and this project has been presented to you for final approval. You should make clear the relative importance and weight that you would give to the financial issues that you raise. (750 words)

Answer 1

(In descending order of weight of issue)

1. Expected Return from the Project: The manager should question the figures presented by the team in terms of the return percentages and ask for a debrief on how those numbers were arrived at and what the estimated accuracy of those numbers are.; NPV and Payback: The cardinal number to any investment in a project is the Net Present Value estimate, ie., the profitability of the project coupled with the rate at which the initial investment is recovered will be crucial to determining feasibility.

2. Source of funding: The manager needs to ascertain how the team proposes to secure funding (debt, loans, equity etc.) for the project and why they have made the choice they made. Does this choice reflect the realities of the financial situation of the company (its financial leverage, for instance) and does it consider the risk associated with such funding? This is crucial as it highlights the exposure the company would have to tolerate towards its creditors.

3. Contingencies: It is crucial to determine the kinds of headwinds expected with a major financial commitment. The team should have a strong understanding of market conditions and set aside plans for expected contingencies and systematic risks that may arise.

Value At Risk: The manager should ask for a Value at Risk assessment that indicates the financial loss possible in the case of failure of the investment.

4. Involvement of External Parties: If multiple parties are involved in the investment, the manager needs to know the kind of exposure each party is willing to take in comparison to their return estimates. The manager has to ensure the right risk return is sanctioned for his company in such a case.

5. Hedge Options: Since the project is investment related, there exists a possibility to hedge bets and decrease the risk associated with the project. The manager should ask the team whether they have explored hedging opportunities and to what degree risks can be curtailed in this manner.

6. Cost consideration: It is essential to efficiently allocate the costs of any investment to maximise return. What impact will the investment have on the Income Statement of the firm in the short-term? This is crucial because if the investment has a weighty short-term impact on income, it may deviate the firm from its set targets for the quarter and the year and the downsizing of profit estimates may concern shareholders. The situation would need to be elucidated properly to avoid panic.