9/21/2018 Business imprint - Profitability of the investment

Yritystulkki.fi

Investments have a significant business role as they may overcome the future of the entire
company.

Timely investment has led companies to international success and failed, incorrect or incorrectly
timed investment has also dropped numerous companies. To facilitate the investment decision,
we have developed YT14 Investment Profitability Calculator, which simultaneously calculates the
profitability of the investment by five different calculation methods.

YT14 Investment Profitability Calculator

.xlsx
(http://www.yritystulkki.fi/download_file/223/19299/)

The careful planning of the investment and the diversification of the options are of great
importance because the planning stage determines the costs. At the implementation stage, cost-
saving changes are difficult to implement. At the implementation stage, the focus will be on the
completion of the investment at the planned time. This is best achieved by purchasing the
product in place, both in the installed and in the test mode, and the delay will result in a fine for
the supplier. The investment made on a company's own job may not be completed on time and
no late payment may be made by anyone.

“
Late investment may at worst knock down the entire
company”

Classification of investments

The order of urgency of investments can be estimated by classifying the investments into
different groups and setting the yield requirement. The following is an indicative yield
requirement for different investments, where a less profitable investment is not executed, and
the means for reaching the desired return target have been found. Often, the investment
assessment is not just about staring at the return value. Often, investing in a particular item
reduces costs to another. On the other hand, investing can be thought of whenever it saves its
acquisition cost back in one fiscal year. In the case of demanding equipment or construction
investments, there is a need to reserve 20% extra on the budget. Even worse, the risk of cost
overruns is the delay in delivery deployment.

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Investment Return Requirement (Compare Calculation Rate)

There is no return requirement for investments based on individual authority orders. The yield
requirement must always be higher than the cost of financing. The following table provides
indicative yield requirements for productive investments. Just investing in real estate (eg
building a rental property) is not considered as an investment but as an investment for which
there are other alternative items. Investment to receive interest income and in many cases
increase the value of the investment over time. The following yield requirements are therefore
not suitable for investments.

The yield
Importance Description of the investment
requirement

No yield
1. Investments based on law or regulations
requirement

2. Securing market position with investments 6%

Replacement or refurbishment of machinery and

3. 10 - 12%
equipment

4. Reducing costs by investing 12 - 15%

5. Increasing profits by investing 15 - 20%

Taking new market areas or making new products with

6. + 20%
investment that is risky

Basics of Investment Accounting

The investment calculation is an estimate of the duration of the investment to determine the
rationality and profitability of the investment. In particular, the necessity of investment
calculations will arise when there are several investment options and have to be ranked. Making
calculations is also reasonable in business operations. When making the calculations, attention
must be paid to the implementation costs, the yields (market) and the financing options. This
review may lead to a better outcome than the original thinking model. The bigger the
investment, the more you have to invest in gathering information. In this case, one of the most
important ways to get information is to ask the experiences of other companies operating in the
rest of Finland.
The present value method
annuity
the internal rate method
return on capital
payback method

Starting values for investment calculation

There are always things to do with investing, which can not be measured by any meter or
estimated by numbers. However, there are always so many things to be evaluated that counting
can be carried out. Number can be estimated

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the total cost of the project, ie the income generated by the basic investment year
expenses incurred annually
calculating the rate of interest
the impact or lifetime of the investment
the residual value of the investment object

basic investment

Defining the basic investment is the easiest part of the investment project, as the amount of
money to be used will be implemented in the near future and its amount can be fairly clear.
Compared to the income and operating costs of the investment, finding out the size of the basic
investment is an easy task. Sure, the definition of the basic investment can be mistaken.
Therefore, the basic investment should be divided into two categories: investment in fixed assets
and working capital. However, all investments are not investments in fixed assets, such as
training or marketing investments. Investing in a house building can be the creation of a new
exhibition area, the magnitude of which can be well compared with the investment in fixed
assets. However, the most typical investment is the acquisition of a new production plant or a
new production plant.

The investment costs of the production plant are:

land acquisition and commissioning
construction costs
interest payments on construction
machine and equipment costs with transport and installation costs
design and often also product development costs by your organization
commissioning costs, such as training, organizing and marketing costs
ancillary investments, which are usually always generated
extra need for working capital
cost overrun booking

Only in the context of a replacement investment can be resolved without the increase in working
capital, but even so rarely. Instead, investing in expansion investments always commits money to
short-term factors such as raw materials, unfinished and finished products, and sales
receivables. The need for working capital can be handled in two ways:
the working capital is included in the basic investment at the level of additional need and
accordingly the capital withdrawn at the end of the holding period is taken into account as
an additional income for the last
every year, the net cost of the investment is deducted from the net interest cost of the
additional working capital requirement,

The first option is recommended.

Continuous revenue and costs

It is most sensible to deal with income and costs annually with one another. The investment must
be able to see separate revenues and costs and be able to estimate the entire duration of the
investment. Sometimes the investment can only lead to cost savings, but even then the rationality
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of the investment and the required return requirement must be remembered. Estimating
revenue is much more difficult than cost estimation. Firstly, the proceeds are estimated from
which the corresponding costs are derived.

Calculation Rate (Compare Income Requirement)

Calculation rate refers to compensation for receiving foreign currency. It is to be considered that
the investment is a creditor who charges interest on the credit he has granted. There is no
interest-free money, although this name is not always available. Thus, the investment must
always be subject to a minimum rate of interest yield on the loan. In the case of investment
calculations, the interest requirement also means that the income and costs generated in
different years can be set at the same line as the investment is born. Money is committed to
investing for several years. The interest rate will determine how much more valuable a certain
amount of money is in today's bag than in five years. Paying interest into future returns and
expenses is called discounting.

EXAMPLE OF CALCULATION SUMMARY

Think that you will get the money of 1000 euros that you invest in the bank and get a 5
percent return on it. As of the end of the year, your money is 1050 euros. When you
raise your sum, it has climbed to 1157 euros after three years. Discounting is the reverse
measure, ie the future net income is "transferred" according to the interest rate to this
day. Thus, having a € 1,000 gain in 3 years' earnings at 5% interest rate is only € 864 in
this day's money.

Duration of investment

Lifetime refers to the economic useful life the company invests in an investment asset. Its length
depends on the company's external and internal factors. For the duration of the life time, the
physical age of the machine, ie the period of time the machine is usable for its original purpose,
may be taken. However, physical life can be continued with modernization and refinement.
However, in the examination of the lifespan, it is appropriate to start from the technical lifecycle,
which means the time when a new machine makes the old machine uneconomical. Generally, the
technical age is shorter than the physical lifetime. Physical age can be multiple compared to the
age of technical-economics. The duration of the investment is calculated by the nature of the
claim. When assessing the affordability of an investment, it is assumed that there are no changes
in the company's operating environment during the selected period that could not be predicted
today. Expectations for the different parts of the investment may vary. The dwell time can be
much longer than the ones in the building. One criterion is to use the depreciation times
approved by the taxpayer, which are generally calculated on the residual value of the previous
year.

Exit times per year:

machinery, equipment and technical equipment for buildings 4-6 years
buildings and structures (store, warehouse, factory, etc.) for 10 to 20 years
residential, office or other comparable building for 25 to 30 years
environmental protection investments 4-6 years
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patents, copyrights, etc. 5-8 years

purchased computer programs from 3 to 5 years
grove, turquoise, mining according to annual consumption
a building or part of the research for 20 years

Residual value

Usually, the residual value is set to zero. This is because the holding time of the investment is
otherwise long and after the holding period the discount value of the residual value is low.
Residual value may also be negative For example, the dismantling of an exhibition facility from
rent lease instead of proceeds is payable. However, the residual value can be assumed to be, for
example, in a lorry or excavator. The magnitude of the residual value can be estimated by
approximating the current used machinery with the current acquisition cost.

The investment calculation methods

The following is a discussion of different calculation methods. The most common are the internal
rate and repayment methods, which are usually used together. The previous emphasizes the
profitability of the investment, the latter financial impact. In addition to the calculation methods,
there is still a large number of company-specific valuation criteria, however, which should not be
given priority over the financial calculations.

Present Value Method

When using the present value method, income and expenses are discounted to the current
interest rate. The investment is profitable if the future net income is greater than the basic
investment. Often, basic investment often needs to be discounted, as implementation rarely takes
place without the time lag of the year. If the rate of interest rate was not used, it should be easy to
make too much profit from investing in net income alone. Consider the following example:

EXAMPLE CURRENT METHOD

The company engaged in the machining industry in the metal industry is planning an
investment of EUR 50,000 to improve its market position. The company has good
relations with its main supplier, who has been told about their desire to increase
purchases of new products. As the issue of market expansion is concerned, the
entrepreneur has set the return on investment by 10%. In this case, the income is
enough for him because the financial interest rate is low and the investment is possible
with the help of the ELY Center.

Output values:
the purchase price is 50 000 euros, delivery time is 3 months only
annual net income for the first two years is € 17,000, but thereafter the main contractor

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the demand for the final product will change so that revenues will drop to EUR 12,000 per
year. certainty,
therefore, we are prepared to ensure that deliveries are no longer in the fifth year.
calculation interest rate 10%
holding time 4 years
the residual value of EUR 10,000

Chart: Cash flows during the investment period

The net The discount PRESENT IN

TIME INVESTMENT
yield factor VALUE TOTAL

50 000
50 000 €
€

1 17 000 € .9091 15 454

2 17 000 € .8264 14 049

3 12 000 € .7513 9016

4 22 000 € .6830 15 026 53 545

+ 3545

This investment is therefore profitable, because the present value of net profits is higher than the
purchase price. An alternative calculation could be the interest rate for which the investment
would still be profitable or thoughtful. that the residual value is less than assumed.

annuity

In the annuity method, the present acquisition cost is divided into equal annual capital gains, ie
annuities, for years corresponding to the holding period. The year includes both the depreciation
and the annuity given in aggregate. Taking the investment is profitable when the annual net
income is equal to the cost of managing the capital. If the investment involves a residual value,

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its present value must be deducted from the acquisition cost. The problematic of the calculation
method is that it is difficult to perceive very different net income years. Using the method on
present computers is quite easy, as they have a ready-made program for this purpose as well.
Business Interrupter YT15 The Mortgage Calculator has a completed calculation model for the
annuity method.

Internal interest rate method

The method of calculation is related to the present value method, with the difference that the
method calls for the investment interest rate. If the interest rate is higher than the target, the
investment is profitable to implement.

Return on equity

The method is a simplified model of the internal rate method. By looking at the next example, the
method of calculation becomes clear.

EXAMPLE OF CAPITAL PRODUCTION METHOD The

starting point is as follows:
Annual net yield after depreciation: annual return on depreciation of € 9,000 - € 5,625 =
€ 3,375
The investment is capitalized on an average basis: (acquisition cost + residual value) / 2
= € 27,500
The average return 100 x annual net income after depreciation) / average capital = (100
x 3 375 €) / 27,500 € = 12.3%

Annual depreciation is (50,000 - 5,000) / holding period 8 years = 5,625 euros

Method of repayment

The repayment method explains how quickly the combined net income of the investment will
pay back the investment, ie exceed the basic purchase costs. The calculation formula is therefore
quite simple, that is, the acquisition cost / annual net yield. Using the previous example, use the
following:

EXAMPLE REQUIREMENT METHODS

Acquisition price EUR 50,000 / annual net income EUR 9,000 = approximately 5.5 years.
Because of its computational ease, the method is commonly used. The disadvantage of
the method lies in the fact that interest is not taken into account. The interest can be
taken into account by calculating the present value for each annual return at the
desired rate, after which the repayment period is checked. According to the method, it is
advantageous to carry out investments that make the money invested as quickly as

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possible. The method does not show the profitability of the investment but the financial
impact. Therefore, it should never be used as the sole method of evaluation, but must be
accompanied by methods that indicate the return on investment, ie the interest rate.

Financing of investments

The financing of the investment is subject to the old rules of thumb, ie the use of money and
money must be in the nature of one another. If a long-term project is undertaken, it will also be
financed with long-term funding. Long-term financial instruments are equity, ie increase in
share capital and capital loan from owners or long-term loan. Short-term loan financing is the
wrong way to finance a long-term investment. When estimating the amount of cash flow, the
amount of depreciation should be increased because they are not paid in money, but the
acquisition cost of the investment itself.

using sensitivity analysisi

The sensitivity analysis examines how the profitability of an investment will change if one or
more factors are changed. After each change, we will investigate the effect it has on the
profitability of the investment. The most important thing is to research and find the most
unfavorable errors of assessment, after which you can most critically assess the profitability of
the investment.

Risk and uncertainty

There is always uncertainty about the future, which means that the calculation methods can
always be thought of as having quite a few uncertainties. The investment involves both
uncertainty and risk, which should be distinguished. When assessing the risks, we are more
confident because we know or assume that we know the risks involved in the project and we also
assume that they know the probability of their occurrence. Uncertainty, again, means that we do
not know and do not even think about events or their occurrence. The risk is therefore
measurable uncertainty, as the investment is almost always a long-term event, it is both the risk
and, in particular, the uncertainty to be prepared by making alternative calculations.

Wirma Lappeenranta Oy
Lappeenranta City Hall
Villimiehenkatu 1,
53100 Lappeenranta
p. (05) 616 3400
www.wirma.fi (http://www.wirma.fi)

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