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Investment Decisions

Should You Make That Investment

Making investment decisions is one of the hardest tasks in business. As any fan of Dragons Den on television will know, sales forecasts, product costs and investments already made are all key criteria, the Dragons query before making an investment.

What’s this to do with Marketing

Very much so, two of marketings Four Ps, Product and Price come into play here. Marketing need to establish the need for a product, its selling price and its sales forecast. Whilst it may be the job of R and D or procurement to design or source the product, marketing need to decide otr at least advise on whether the investment is sound. There are various tools marketers and finance managers use when making investment decisions. This is just a short overview, further reading if you are interested is advisable.

Before looking at the tools, let’s take a hypothetical example.

  1. ACMO Engineering are considering buying a new machine tool, it will cost £75,000 to buy.
  2. The tool will make Widgets Ones, by using the tool, the manufacturing cost per Widget will fall by 50% to £10 From £20
  3. They sell 5000 Widget Ones per year.

Payback Model

This is the simplest and widest use model. It’s looking at how long it will take for the investment to get paid back

Year Investment No Widgets Cost Now Total Now Cost Future Total Future Saving
-£75,000
1 -£25,000 5000 £20 £100,000 10 £50,000 £50,000
2 £25,000 5000 £20 £100,000 10 £50,000 £50,000
3 £75,000 5000 £20 £100,000 10 £50,000 £50,000
4 £125,000 5000 £20 £100,000 10 £50,000 £50,000
5 £175,000 5000 £20 £100,000 10 £50,000 £50,000

This is a simple example, it’s easily seen that the investment will be paid off in year two, if we assume sales will continue for five years, then the investment handsomely pays for itself.

If though, the new machine instead cost £250,000, it doesn’t look so good!

Year Investment No Widgets Cost Now Total Now Cost Future Total Future Saving
-£250,000
1 -£200,000 5000 £20 £100,000 10 £50,000 £50,000
2 -£150,000 5000 £20 £100,000 10 £50,000 £50,000
3 -£100,000 5000 £20 £100,000 10 £50,000 £50,000
4 -£50,000 5000 £20 £100,000 10 £50,000 £50,000
5 £0 5000 £20 £100,000 10 £50,000 £50,000

The tool can be tweaked to allow for changes in sales volumes and build costs. It can soon get complex when you allow for inflation and try to handle more integrated projects.

Net Present Value (NPV)

The money in your bank or pocket is worth more today than it will be in the future thanks to inflation. By using the NPV tool, you evaluate the investment in today’s money terms. If the result of the NPV calculation is positive, the investment makes sense, if negative it doesn’t.

The formula can be off putting!

Net Present Value Alternative Formula

It isn’t as bad as it looks

Co is the initial investment
T is the number of years
Ci is the cash flow in each year
r is the Discount Rate (such as the interest paid on debt)

Fortunately there is an NPV tool built into Excel. NPV is considered a superior tool for evaluating projects. If you are approaching external investors its use is strongly recommended.

Forecast Accuracy

Whatever tool is used, there is a reliance on marketing to come up with sales projections and pricing forecasts. Going back to Dragons Den, the investors are soon put off by unrealistic forecasts of either. For most of us business is tough, growing share in a competitive market nearly always results in some form of retaliatory action which may reduce prices.

Scenarios

The beauty of using tools is that it is easy to “play” with the figures to cover various scenarios. Back to our original example; What if sales fall or rise by 10% each year for example. If when you put in pessimistic forecasts and still get a positive return, then it definitely looks like a good investment. On the other hand, if it goes negative for only a small change, then only proceed after making a more in depth evaluation.

 

 

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