Object Finance Analysis Forex

A Feasibility or Feasibility Study lays down the conditions that make possible the investment project, or allow its successful implementation, it also determines the functions and priorities to be taken into account throughout its development.

Introduction:

To perform this feasibility study must use traditional methods to the Financial Evaluation of investment projects such as the Net Present Value, Internal Rate of Return and Recovery Period.

Risk considerations in evaluating an investment proposal can be defined as the process of developing the probability distribution of some of the economic criteria. Generally, the probability distributions that are most common are obtained in an evaluation, under the
Net Present Value and Internal Rate of Return. However, to determine the probability distributions of these bases of comparison, knowledge of the probability distributions of uncertain elements of the project such as: life, cash flows, the interest rates, changes in parity, inflation rates among others.

The financial evaluation of investment projects is associated with a risk that is explained by the uncertainty that means considering a zero NPV, ie the project is affordable because it invests only recover a NPV greater than 0, means that the project is profitable and the investment earnings recovery and a NPV less than 0, ie that the project is profitable without taking into account other variables such as the IRR which has to be greater than the opportunity cost capital.

This justifies the need to study the uncertainty, which means they can more things happen that will occur.

That is why the analysis of projects has developed other procedures such as sensitivity analysis, the analysis of deadlock, and the simulation and decision trees.

Simulation is sophisticated statistical bases to deal with uncertainty by bringing together different components of cash flows on a mathematical model that repeating the process many times, you can set a probability distribution of returns of projects. The performance of the simulation provides an excellent basis for making decisions as the decision-maker may consider a continuum of risk alternatives – performance rather than a single point estimate.

Definition of simulation.

“Simulation is a numerical technique that is used to perform experiments on a digital computer, from a logical-mathematical model is a computer program that describes the behavior of system components and their interaction over time.” (1)

“Simulation is a specific type of modeling on the attempts to represent reality in a simplified form. As with the mathematical-statistical models, simulation models have a number of inputs or input data that researcher included in the model and a set of outputs or results that flow from it. ” (2)

“Simulation is the representation of a process or phenomenon by another more simple to analyze their characteristics, but the simulation is not only that it is also very every day, now may be from simulating a test, you the teacher makes his student for an examination of the ministry, the production of textiles, food, toys, construction of infrastructure through models, to virtual training of fighter pilots. ” (3)

“The simulation is just using a model system that has the desired characteristic of reality, in order to reproduce the essence of the real operations (…)” (4)

“It is a representation of reality through the use of one model or another mechanism that will react the same way that reality under a given set of conditions.” (5)

The simulation is very useful to solve a business problem which is not known in advance all the values of the variables, or only partially known, and no way to find out easily.

Involves the construction of a certain type of mathematical model describing the performance of the system in terms of events and individual components. In addition the system is divided into elements and their interrelationships with predictable behavior, at least in terms of a probability distribution for each possible system states and inputs. Misuse of the simulation.

The financial manager is like a detective, who must use all the tracks. The simulation should be as another way to obtain information on expected flows and risk management. But the final investment decision applies only one figure, the net present value.

The financial management is not given the distributions of cash flows, if the net present value or internal rate returns. Is not it better a full distribution of net present values for a single number? But we will see that this reasoning more is better and leads the CFO into a trap.

Cash flows for each iteration of the simulation model become a net present value discounted at the risk free rate. Why not be discounted at the opportunity cost of capital? Because, if you know what is this, do not need a simulation model, except perhaps to facilitate the forecasting of cash flows. The risk-free rate is used to avoid prejudging the risk.

The expected net present value does not take into account the risk. The risk is reflected in the dispersion of the distribution of net present value. Thus the term net present value takes a very different meaning than usual. If an asset has a number of possible current values, it makes little sense to associate the current value with the price at which an asset could be sold in a competitive capital market.

If two unrelated projects are combined, the net present value risk of the combined projects will be lower than average risk of the net present values of two separate projects.

This not only goes against the principle of activity of value, but also encourages project developers to subvert the system marginal joint proposals.

It is very difficult to interpret the distribution of net present values. Since time is not risk-free opportunity cost of capital, there is no economic rationale for the reduction process. Since the mechanics as a whole is arbitrary, managers say they can only decide how or what to do if you never get inspired.

Some of these difficulties can be avoided by introducing a distribution of internal rates of return. This avoids the use of an arbitrary discount rate at the expense of introducing the problems associated with the internal rate of return. In addition, then left to contemplate the distribution manager without guidance concerning the appropriate balance between expected return and variance of profitability. However, it could use the standard deviation of the internal rate of return as an approximation of relative risk of projects in the same line of business.

Steps to simulate an investment project.

The steps to simulate an investment project are well exposed by Raul Coss (6) and correspond to those defined by other authors in general.

The logic to be followed to simulate an investment project is:

1. Input data.

• Tax rate.
• Opportunity cost of capital.
• Parameters of the project and their probability distributions.

2. Generator of random variables.

• Normal.
• Uniform.
• Exponential.
• Empirical.

3. Investment model.

Depreciation.

• It is calculated based on the type of asset and industrial activity in which they are used.

Evaluation Criteria.

• Internal Rate of Return.
• Net Present Value.
• Return on Investment.
• Recovery Period.

4. Probability distribution of the evaluation criteria selected.

• Histogram.
• Cumulative histogram.

5. Statistical analysis.

• Media.
• Standard deviation.
• Range.

6. Decision.

Conclusions.

• The advantages of using a financial simulation model evaluation the feasibility of an investment project are that these models are applicable to many products and sectors. Can be adapted to the specific characteristics of the draft.
• A financial simulation model allows you to devote your attention to the decision of whether to invest in the project, or concentrate on improving those aspects that can do more profitable. Instead of wasting time on designing complex financial models, you limit their use.
• Improved decision-making process because when its provisions have a high financial impact, a simulation model allows you to change the key points of your investment and evaluate multiple scenarios. You will immediately see the effects, and may reach optimal decisions in a fast and easy.

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