Management Of Risk And Strategic Investment Assignment Sample

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1.0 Introduction to Management Of Risk And Strategic Investment Assignment Sample

In this report, strategies that may enable firms design a more flexible approach that will help them in making better investment decisions have been discussed. It concentrates more on explaining the influence that various phases of Project Sable bear on the worth of the project. While other older methods such as NPV do not capture opportunities in the future, real options give a company the chance at the right time. The plan also covers the right way of entering new markets besides the dangers involved. It is best if businesses acquire more information and invest on a significant scale later on, step by step. This assists them in preventing any potential losses and also enable them to make the right decisions at the right time and in the right way by using proper data.

Management Of Risk And Strategic Investment Assignment Sample

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2.0 Discussion

2.1 Project Sable: Understanding Its Value

a) Value of Project Sable with Only Phase 1

The cost will be $100 if the company decides to invest only in Phase 1 of Project Sable. The expected outcome of winning is $100 with probability ½ and the expected loss which is $60 with probability ½. In the present time, it is $100 because, at the expected value, it is $110 with discount. The initial investment is also $ 100 and that too positive thus making the Net Present Value (NPV) is equal to zero. This pretty demonstrates that with no reference to the subsequent phases of the project, the project does not generate more value.

b) Value of Phase 2 If Decided Today

Investment in the second phase of the project can be undertaken if the company will have to invest $ 100 today. The expected returns on cash flow in relation to Phase 2 greatly depends on the result in Phase 1. Assuming that the targets in Phase 1 are met, Phase 2 would have a capability to earn up to $ 160 while if the goals of Phase 1 fail to materialize, Phase 2 would be able to earn only up to $ 60 (Iastremska et al. 2023, pp.117-133). The expected value of the investment is $110, which then makes $90.91 when discounted. As the cost of Phase 2 is $100, the net present value of it is also negative or precisely - $ 9.09. Another implication is that, if the company had to embark on Phase 2 today, without having knowledge of the result of Phase 1, the investment is not worthy.

c) Value of Project Sable with Flexible Decision on Phase 2

When the company is free to decide on phase two depending on the result of phase one, the project increases its worth. Indeed, if phase 1 is successful, then, phase 2 creates a total incremental benefits of $ 220.33 and the net present value amounts to, $ 200.30. That is, when all the investments have been deducted, the resulting NPV is $0.30. In the case of the lack of success of Phase 1, at that time the Phase 2 is not funded and the company does not experience any losses (Flammer and Ioannou, 2021, pp.1275-1298). The forecasted cash inflow in the last year is $127.42 and when applying the discount factor, the present value is $115.84; thus making the net cumulative NPV equal to $15.84. This is to mean that having an option of making the decision later can actually enhance the value of the project.

d) Value Allocation between Real Options and Assets-in-Place

Non-energy companies and energy companies that are not keen on major exploration activities should therefore focus their value on assets-in-place and real options as this paper has shown. Project Sable is valued using the concept of assets-in-place and real option (Ashta and Herrmann, 2021, pp.211-222). These assets include the outcomes of the first phase of investment that is the Phase 1 investment. The real options mean the ability to make a decision on the second phase at the convenient time. The value of this project is $ 115.84 in total, but part of it is based on Phase 1 and the possibility to decide whether to continue with Phase 2. Because of this, flexibility to defer Phase 2 brings much benefits.

e) Recommended Debt and Equity for Funding

Since Project Sable has to be financed externally, the company has a problem of the right proportion of debt to equity. In the light of efficient capital markets and given that the risk-free interest rate is 5%, the company can leverage on the use of both debt and equity. It shall be able to secure $100 in debt for Phase 1, averting the need to invest preliminary monies before starting the venture (Hanlon et al. 2022, pp.1150-1214). This is particularly because in the event phase one yields positive results, the company can seek an additional $100 funding for phase two. Overall, through this method of financing by both borrowing funds and selling shares, the company can manage risks and returns for financial stability without compromising on the cost of ownership.

2.2 Understanding the Investment Decision

There are various factors that the management of a manufacturing company should consider when deciding on product development in regard to the key technology available for licensing. It is the division president belief that the product is good and should be introduced to the market. However, to start and market the product, an initial capital of $ 145 million is required (Chenarides et al. 2021, pp.270-279). Based on the evaluation from the above analyses, the investment committee has to make its decision on whether this project should be recommended for implementation.

Figure 4: Investment Decision

(Source: Self-created in MS Excel)

a) Evaluating the Investment with Discounted Cash Flow (DCF) and Debate over the Discount Rate and Evaluating Growth Potential

1. i) Evaluating the Investment with Discounted Cash Flow (DCF)

In conclusion of the analysis to figure out whether the headquarters is financially feasible or not, the Net Present Value of 15% was conducted. These cash flows include the projected earnings for the first three years that are $10,000,000 and $12,000,000 and $15,000,000. If these cash flows are discount at 15% the total present value of the investment is $27.63 million (Ahmad 2024, pp.401-422). When the initial investment is $145 million, the NPV of the project is negative at (-) $ 117.37 million. An NPV that is less than zero means that the project cannot be financially supported given the discount rate adopted here.

1. ii) Debate Over the Discount Rate

Concerning the course of action to take, the division president is against the use of a 15% discount rate. This she states that should be valued at 10% as is any other project investment or as stated at 8% as it is a strategic project (Lakshan et al. 2021, pp.241-266). Lower discount rate would also increase the present value of the future cash flows, thus there is a possibility of getting a positive NPV.

The analyst further asserts that product launches are more risky than business operations already under way, hence the need for a higher discount rate increases. In the present case, if the investment is somewhat riskier then Haringey may come across a low rate beneficial in some instances but in effect mislead them (Cui et al. 2021, p.101533), The next aspect that the committee needs to determine is exactly which discount rate exhibits the correct level of risk on the project.

iii) Evaluating the Growth Potential

The division president adds that the collective growth potential of the project has also not been well estimated. The latter is also extend about another two phases of investment to be discussed below:

1. It is expected that the additional cash flows will happen of $20M from the investment of $250M in third year, $24M in the fourth year and $30M in the fifth year.
2. Additional investment of $450 million after another three years would produce the cash flows amounting to $40m, $48m, and $60m.

Responding to this, the analyst questions and challenges such an approach stating that each phase should be assessed separately (Settembre et al. 2021, pp.107-132). The committee should not count on future investments to be made unless the committee gets a nod on the investments for it to make an investment.

b) Using the Real Options Approach

That kind of DCF does not incorporate flexibility. In a real options analysis, the project is viewed as a number of options or investments. The first phase allows the company to have an option in the next phase but they are not compelled to do so. This flexibility adds value.

To value the real option, the Black-Scholes-Merton model may be employed with simplicity, if σ is between 40% to 60% (Wang et al. 2021, pp.355-389). This method has the merits of placing high value on the right to make future investment which can make the project scooping more attractive.

c) Considering the Year 6 Investment

Since the third phase can only be carried out if the initial two phases are successful, there is a good chance of having the third phase too. This relativized valuation method can be incorporated into an options-based model that may allow the company to make value judgement on its addition.

2.3 Identifying when to invest in SEP or other assets requires a few considerations before entering the market fully

a) For Entry Immediately the Net Present Value

That is, if the company enters “Market A” right away, the amount that will be required to invest is one hundred million dollars. If the product is successful, the total market will be able to produce its worth that is $160 in one year. In case it fails it will only bring a return on investment of eighty dollars (Berthet 2022, p.802439). Since the odds are 50% of the time the results will be good, then the expected value will be $120. However, this value decreases to -$99.52 if the project is discounted at 5%, which indicates that this project is not good if entered immediately.

Market B, in particular, requires an investment of $55 in this case. Market for the product is that if the product is successful then one is able to earn $140 within one year. If it does not achieve this, it can only gross $25 (Cohen and Kouvelis, 2021, pp.633-643). The expected value is $82.5. The NPV is also negative at -$54.52 when discounted at 5% indicating that it will be a poor business investment it entered immediately.

Since both the markets have a negative NPV the entry may not be done immediately and this must be taken into consideration.

b) Considering Different Entry Strategies and the best strategy for Entry

1. i) Considering Different Entry Strategies

Since it is not possible to enter both markets immediately due to its unprofitability, the company should consider some strategies. It could penetrate only one market and then think about the second afterward. It could also wait before entering any of the above market to collect more information about the success potential of the product.

Some of them can be eliminated without further quantitative computations: It is clear that entering both markets at the same time will not be profitability because both markets have negative NPVs. The authors recommend that the company should not make a final decision but rather monitor more information about the product’s attractiveness (Alkaraan et al. 2022, p.121423). Thus, success in Market A may be followed with an entry into Market B, whereas a failure there can be compensated in Market A.

1. ii) The Best Strategy for Entry

In other words, the best strategy is to lever them up only after some time. What is more, the company can take one or two years deciding what is the best move to make. This approach can be useful for the company as it helps to get more data and, therefore, minimize uncertainty. That’s why if new information indicates that the product will be successful, one should first enter Market A, and then Market B.

c) A General Rule for Capital Budgeting

The relevant rule to be followed when possible in capital budgeting is one should not invest big when uncertain. Instead, companies should seek flexibility. It is advisable for them to invest small amounts first and substantially invest once they are sure of the chances of success (Kim et al. 2021, pp.202-230). It provides certain level of risk reduction and the likelihood of making a correct choice is also higher.

d) Adding a Third Market (C)

The same applies when a third market known as Market C requiring an investment of $40 million with a potential of $55 million value when successful and $40 million in event of a failure. It also pointed out that the company should not make hasty investments (Sahoo and Goswami, 2023, pp.25-48). However, it should evaluate all its opportunities and expansion into the markets only when necessary.

By so doing the company can be able to make the best decision and maximize on its returns and at the same time able to minimize on risks reformed.

3.0 Recommendations

Firms need to avoid putting their money in a large amount in an investment especially if the returns are not quite clear. They should not take such a risky step at least, and wait for more information instead of that. This is because uncertainty has a tendency of resulting to financial losses if a particular project does not yield the required outcomes. Real options analysis is effective as it provides business with an opportunity to make decisions in light of results. Discount rate is also essential while estimating the value of the cash flows, as a right one can bring a bad project to look good or vice versa.

Also, the management should not commit itself to long-term plans without reviewing the effects of prior phases. For instance, Phase 2 can be considered if Phase 1 of Project Sable affirms itself to accomplishing the outlined goals. Indeed, in such a situation, it is more appropriate to cease the operations of the business in phase 1 and prevent incurring further losses. The same case applies when developing new markets, companies should go into the particular market and evaluate the outcomes of the entry before venturing further. In this way they can minimize risk factors and increase the likelihood of achieving these results. By applying systematic procedures, one is capable to find the right and financially secure outcome.

3.0 Conclusion

However, there is some essential information to make the investment decisions with caution and they are as follows: NPV and the other traditional techniques do not often capture the values of waiting and learning in consequent phases. Real options analysis provides a proper way for the management of risks because it shows when it is suitable to invest tracing from the market condition. By this way, the risks of financial aspect and the probability of success are managed and enhanced. One way through which businesses can adopt the use of analytical and logical skills is through the suitable and smart decision-making processes which will enhance organizational profitability while the unsuitable ones can be avoided due to their impacts on the organizational loss.

Reference List

Journals

• Ahmad, M., 2024. The role of recognition-based heuristics in investment management activities: are expert investors immune?–A systematic literature review. Qualitative Research in Financial Markets, 16(3), pp.401-422.
• Alkaraan, F., Albitar, K., Hussainey, K. and Venkatesh, V.G., 2022. Corporate transformation toward Industry 4.0 and financial performance: The influence of environmental, social, and governance (ESG). Technological Forecasting and Social Change, 175, p.121423.
• Ashta, A. and Herrmann, H., 2021. Artificial intelligence and fintech: An overview of opportunities and risks for banking, investments, and microfinance. Strategic Change, 30(3), pp.211-222.
• Berthet, V., 2022. The impact of cognitive biases on professionals’ decision-making: A review of four occupational areas. Frontiers in psychology, 12, p.802439.
• Chenarides, L., Manfredo, M. and Richards, T.J., 2021. COVID‐19 and food supply chains. Applied Economic Perspectives and Policy, 43(1), pp.270-279.
• Cohen, M.A. and Kouvelis, P., 2021. Revisit of AAA excellence of global value chains: Robustness, resilience, and realignment. Production and Operations Management, 30(3), pp.633-643.
• Cui, X., Wang, C., Liao, J., Fang, Z. and Cheng, F., 2021. Economic policy uncertainty exposure and corporate innovation investment: Evidence from China. Pacific-Basin Finance Journal, 67, p.101533.
• Flammer, C. and Ioannou, I., 2021. Strategic management during the financial crisis: How firms adjust their strategic investments in response to credit market disruptions. Strategic Management Journal, 42(7), pp.1275-1298.
• Hanlon, M., Yeung, K. and Zuo, L., 2022. Behavioral economics of accounting: A review of archival research on individual decision makers. Contemporary Accounting Research, 39(2), pp.1150-1214.
• Iastremska, O., Tryfonova, O., Mantaliuk, O. and Baranets, H., 2023. The impact of strategic decisions on the future development of organisations and economic dynamics. Futurity Economics&Law, 3(4), pp.117-133.
• Kim, S., Lee, G. and Kang, H.G., 2021. Risk management and corporate social responsibility. Strategic Management Journal, 42(1), pp.202-230.
• Lakshan, A.M.I., Low, M. and de Villiers, C., 2021. Management of risks associated with the disclosure of future-oriented information in integrated reports. Sustainability Accounting, Management and Policy Journal, 12(2), pp.241-266.
• Sahoo, S.K. and Goswami, S.S., 2023. A comprehensive review of multiple criteria decision-making (MCDM) Methods: advancements, applications, and future directions. Decision Making Advances, 1(1), pp.25-48.
• Settembre-Blundo, D., González-Sánchez, R., Medina-Salgado, S. and García-Muiña, F.E., 2021. Flexibility and resilience in corporate decision making: a new sustainability-based risk management system in uncertain times. Global Journal of Flexible Systems Management, 22(Suppl 2), pp.107-132.
• Wang, J., Zhao, L. and Huchzermeier, A., 2021. Operations‐finance interface in risk management: Research evolution and opportunities. Production and Operations Management, 30(2), pp.355-389.