Q.1. a) Examine the scope of ‘fundamental analyses in investment process? How it
ID: 2557661 • Letter: Q
Question
Q.1. a) Examine the scope of ‘fundamental analyses in investment process? How it would help a global investor in choosing his/her portfolio investment?
b) Mr. Khalid faced with two investment projects A or B. Each requires an initial investment of OMR 100 000, with the following anticipated cash flow ;
Year
Project A
Project B
Year 1
20000
30000
Year 2
20000
40000
Year 3
20000
30000
Year 4
20000
10000
Year 5
20000
10000
Year 6
20000
10000
The cost of capital is estimated at 8%
Find:
a. The Pay Back Period for each project
b. The Average Rate of Return on each project
c. The Net Present Value of each project
d. What difference would it make if the cost of capital were higher (or lower?)
Year
Project A
Project B
Year 1
20000
30000
Year 2
20000
40000
Year 3
20000
30000
Year 4
20000
10000
Year 5
20000
10000
Year 6
20000
10000
Explanation / Answer
Answer 1:
Fundamental Analysis
Fundamental analysis results in a value assigned to the security in review that is compared to the investment's current price. Investors use the comparison to determine whether a long-term investment is worth buying because it is underpriced or if it is worth selling because it is overpriced.
The majority of investors who want to evaluate long-term investment decisions start with fundamental analysis of a company, an individual stock or the market as a whole. Fundamental analysis is the process of measuring a security's intrinsic value by evaluating all aspects of a business or market. Tangible assets including land, equipment or buildings that a company owns are reviewed in combination with intangible assets such as trademarks, patents, branding or intellectual property. When evaluating the broader scope of the stock market, investors use fundamental analysis to review economic factors including overall strength of the economy and specific industry conditions.
The fundamental analysis of stocks is the cornerstone of investing – and the foundation of most of the strategies covered in this tutorial. It involves evaluating a security using quantitative and qualitative factors to answer questions such as:
Answer 2
Pay Back Period ( when Cash flows are uneven)=
Years before full recovery+ Unrecovered cost at start of the year/Cash flow during the year
Pay Back Period
Project A = 100000 / 20000
= 5 years
Project B
Cash Flow
Cumulative Cash Flow
Pay Back Period = 3Years ( since full cost has been recovered in 3rd year)
b.Average Rate of Return
Average Rate of Return = Average Net Income / Average Investment
Average Investment = 100000/2 = 50000
Project A= 20000 / 50000
= 40%
Project B = {(30000+40000+30000+10000+10000+10000)/6} / 50000
= 21667 / 50000
43.33%
c. Net Present Value
Project A=
Initial Investment = 100000
Annual Cash Flow = 20000 for 6 years
Cost of capital = 8%
Items
Years
Cash Flow
P.v. @ 8%
Present value of cash flow
Annual Cash Flow
(1-6)
20000
4.623
92,460
Initial Investment
1
(100000)
1
(100000)
Net Present Value
(7540)
Project B
Year
P.V. @ 8%
Cash flow
Present Value of Cash flow
1
0.926
30000
27780
2
0.857
40000
34280
3
0.794
30000
23820
4
0.735
10000
7350
5
0.681
10000
6810
6
0.630
10000
6300
Total
106340
Initial Investment
(100000)
Net Present Value
6340
d. If the cost of capital is higher then NPV will be decreased than the above calculated NPV. And If the cost of Capital is lower then the NPV will be increased than the above calculated NPV.
Cash Flow
Cumulative Cash Flow
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