- Introducing new theory on evaluating project and ideas.
- The more volatile the economy becomes, the lower the desire to undertake long - term investments in productive sectors, in such circumstances the funds are mainly focused on early productive sectors with short repayment period , such as the service sector (especially the brokerage, speculation, etc.).
- Is the use of dispersion indices for expression and measurement of the risk is reasonable?
In evaluating investment conceptions generally given the notion of the time value of mazuma (=money) over the projected time periods for investment and subsequently the expected earnings, simple analysis and valuation methods are generally predicated on discounting or not discounting cash flows (as in The following table is summarized) utilized.
The methods mentioned include the rate of return, profitability, and the period of return on capital. These methods merely represent the hypothetical picture of the financial and economic perspective of investment conceptions in general and on the substratum of postulations. Ergo, the results of this method are plenarily dependent on the posits (/assumptions) made in advance and by transmuting one of the postulations postulated (for example by updating the data) the corresponding consequences on it change accordingly.
This imperfection(defect) causes in the authentic world a prodigiously and sizably voluminous deviation between the genuine data and the initial data in the evaluation models discussed because these methods are utilized statically or predicated on categorical postulations and merely provide a dummy image of the financial consequences, which rudimentally lacks logical reliance because in the authentic world, data used under the influence of time and sundry changes, or simply transmuting and failing to meet the initial postulations, is thoroughly transformed.
Ergo, different changes conspicuously lead to the discussion of the perils affecting cash flows and their true value.Yes peril! – i.e., a phenomenon which is sometimes identifiable, is sometime unrecognizable (unexpected or capricious) beforehand and, of course, is very paramount in investment.
Over time, some have endeavored to quantify risk by utilizing a series of bespeakers or indicators (such as measures of dispersion and in particular ‘Standard Deviation’) or by defining acceptable coefficients (such as Beta coefficient, etc.,) to some extent but, in the authentic world, Risks engender capricious impacts due to the nature of the functional, behavioral, and perpetual variability (with varying intensity and impotency) in different situation.
If, according to some conceptions made by Western scientists, risk is visualized as the scattered points around a hypothetical average line (such as the capital market line or kindred criteria in CAPM) and the extra above the peril free that an investor requires in order to be compensated for of a certain investment is taken into account as a risk premium (or investor adscititious/excess return in comparison to imperil-free return), so Ineluctably, risk must still be divided into systematic (quantifiable) and non-systematic jeopardies.
Consequently, a paramount portion of the perils will not be scientifically quantifiable yet. Such theories do not yield reliable results in volatile and crisis economies or even in highly sensitive capital markets. Ergo, an incipient theory about the process of peril identification and quantification has to be put forward.T o this end, it should first be noted that investment risk (in first tier /layer) is a cumulation factor or is composed of sundry components. Risks are born as the result of current events in a society.
Sometimes, an ostensibly minute decision (such as lowering interest rate) taken by the governing body of that society results in far-fetched upheavals and affects different markets in general. That is why it can be verbalized that (other than coercive forces) certain resources in a society engender or thoroughly eliminate peril.
On the other hand, as the result of international interactions sundry risks may be composed unexpectedly or, at least, their range of intensity and impotency face with lots of changes. Today, the structure of international trade cognations has been targeted by puissant economies in international trading, so to verbalize of free trade seems to be absolutely cockamamy. Even in the united States of America, once claimed to be an ideal symbol of a free economy in the world as well as a leading /progressive country in following free trade formula, regime interventions in the economy (both domestically and internationally) is quite evident.
The imposition of cumbersomely hefty tariffs on international trade, the imposition of explicit restrictions on trade, and the utilization of the international banking system to impose economic sanctions on multiple countries, pellucidly demonstrate that the logic of free economy and trade which was supposed to rely on the consummate economic competition in that country is going to be extirpated.
The fact is that the economies of different countries are moving rapidly and indisputably toward becoming statehood (/governmental). Thus, the free trade system will gradually face many obstacles. On the other hand, by incrementing regimes’ intervention in economy, a kind of economic war is triggering between countries.
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Currently, the commencement of a trade war, whose impact on the scope of world trade is facilely prognosticable, has clicked by the united States of America on the one hand and the European countries, China and Canada, on the other hand.This trend even affects economic cumulations (and the phenomenon of economic convergence) and disrupts them. For example, Britain’s decision to leave the European Amalgamation/Union is the first blow to that organization, and if another economic power of that organization (ineluctably) decides to exit, the survival of the European Organization will be prodigiously arduous.
This is not surprising, of course, because regime intervention in the economy reinforces boundaries and fences.When the economy emerges as a potent weapon and (mistakenly) perceived to be more facile and more cost-efficacious to utilize than the military and sundry weapons, business cognations are defined differently.
In this regard, the analytical models and methods must additionally be authentically formulated to accurately map the resulting peril.If the authenticity of the diminution of the esse of the free economy (especially in countries where much of their economic activity is controlled by the regime and with its direct interference) is accepted.
The issue of maintaining economic stability and shakiness or fortifying the monetary base of countries becomes paramount because experience shows that as regime intervention deepens in economic activity, the efficiency of the national economy will decline due to transmutations in occupational specialization criteria, widespread institutional amotivation (i.e. lack of motivation) and the spread of financial and economic corruption become less and less, and the continuation of this trend will ineluctably lead to convivial discontent and more instability in national economy.
Regimes use very potent implements such as central banks, ministry of economy, commerce, customs, etc. to run their intentions in the national economy. With the assistance of such implements, the order and the balance of (all the financial, monetary, currencies, credits, precious coins and metals … housing) markets, can be facilely perturbed whenever the will is to make or even if an erroneous decision is made.
The resultant of logiclessly injecting shocks by governmental implements into the markets, of course, can facilely be optically discerned as a downturn in value of national currency and, ineluctably, instability in national economy. Consequently, it must be acknowledged that the jeopardies engendered and posed by the regime and governmental entities are a key factor in evaluating investment plans and that is why it is compulsory to move towards an incipient relegation of perils and their nature.
Moreover, it should be noted that in additament to the peril and return (or profitability) factors considered in Western theories, other paramount factors are involved in the discussion of investments. On the other hand, it is pellucid that both risk and return factors, in turn, are the resultant of different varying factors and that is why great discrepancies always visually perceived when the results of economic calculations carried out during feasibility study stage of investing conceptions and the results of calculations predicated on authentic data (as booked in ledgers) are compared.
This fact can facilely be observed in any country having volatile economy with shaky national currency. In such economies, Quantity of the cost factor of each investment conception and consequently the capability of required finance (considering the period of repayment) and the value chains engendered (especially in macro and national plans), have the indisputable impacts (in engendering different risks and the rate of return).
In fact (from the second a moiety of the 19th century onwards, following the exordium of the portfolio theory), risk and return levels/rates are generally considered as the final factors of deciding on investment conceptions. However, it should be noted that these two factors themselves are highly dependent on other factors such as time, cost, quantity of resources required, organization and management, economic stability and the national currency base situation.
Consequently, it should be examined that what is the relationship between risk and rate of return (Contrasting with one another) in one hand and the factors of time, cost, value chain, executive organization and management as well as economic stability i.e. the determining factors of peril and returns levels to the other hand (or vice versa) and withal among each mentioned factors (in facing with the others) rudimentally.
If the economic situation of a country (regardless of the causal or cause and effect relationship) is analyzed, the following statuses can be imagined:
A) Economic stability: means the situation with an absence of excessive/severe fluctuations in the markets of monetary and currency, finance, capital, precious metals and commodities, housing, rental of capital goods, consumer goods, labor on the one hand, and continued economic growth of manufacturing, agriculture and Services on the other hand.
An economy with fairly constant output growth and low and stable inflation would be considered economically stable.
B) Economic Instability: The situation of drastic fluctuations in markets of money and currency, finance and capital, consumer goods, capital goods and labor on the one hand, and seeing negative economic growth (or at least slowing or stopping it) in various sectors of production, agriculture and services on the other hand.
An economy with frequent large recessions, a pronounced business cycle, very high or variable inflation, or frequent financial crises would be considered economically unstable.Among the most important indicators of economic change: rising trend in rates of inflation, unemployment, buying durable goods and hoarding, false employment (especially in brokerage, speculation, trafficking, arbitrage) and capital flight as well as disproportionate profit rates
In various markets, the decline in public purchasing power and the escalating rate of stagnation in expensive commodities and, of course, the rise in rates of economic corruption and widespread poverty and severe class divisions, caused by the creation of various rents (usually by the government).
In the case of economic stability, it is postulated that the Western theories (such as theories cognate to the pricing model of capital assets) or the prevalent methods utilized in evaluating investment ideas ( like rate of return) show the financial and economic perspective of the ideas under consideration, provided that the key posits/ assumptions applied in respective calculations arranged on cash flow substratum, remain absolutely unchanged in the time-frame/ schedule associated with those calculations.
Consequently, it is postulated that the precision of such posits utilized, such as the following postulations/ assumptions, and the durability of the forecasts and estimates are directly dependent on the continuation of the period of economic stability.
1 Estimated amount of cost accrued
3 Product prices
4 The amount of products manufactured
5 Interest / interest rate stability
6 Relative stability of inflation rate
7 Calculated discount rates
8 Relative Stability of the National Currency Base (and foreign exchange Rates)
9 Low mobility and mobility of ‘liquidity’ in markets and relative ease of venture capital in society
In the valuation methods presented, the parameters of amount, duration, price and quantity of product, interest rate and discount factor estimated and pre-surmised for calculating yields as posits used to perform financial and economic calculations, However, each of the above parameters applied over the surmised period of time for calculations have the scope of skepticality change that engenders different financial and contractual jeopardies.
Ergo, the application of each of the above parameters requires a congruous assessment of the precision of the data and the prognostication of the range of possible changes.
Conspicuously, vicissitudes/changes in each of the parameters mentioned will impose clear consequences to the investor. For example, if the inflation (R.I) rate exceeds the interest rate (i), i.e. R.I>I, not only The owner of the mazuma(=money) and the depositors will not make a profit by renting out their own mazuma, but withal they will lose at least as much as the difference between the inflation rate and the interest rate. In this situation, consequently, investing will logically stop and funds will probe for other ways to make a profit.The risk of exceeding the rate of inflation in the above situation has a specific origin .it is generally planned by some governments for specific purposes.
As per the valuation methods suggested by the western scientists, the present value (PV) of a sum of money is simply computed by dividing the future value (CF) of sum money by discounting rate as follow:In this method the interest rate is the substructure of calculation. But is it authentically possible to calculate the authentic value of future mazuma for the present (or time zero) utilizing this simple method? How is it possible to calculate the present value of money when the inflation rate exceeds the interest rate?
On the other hand, according to the above method (i.e., the method of calculating the present value of mazuma), if inflation is negative in a society, it is not plausible to utilize financial resources to invest in the engendering (/production) of commodities because a negative inflation rate denotes that commodities will be more frugal (cheaper) next year. In other words, the future value of mazuma (in this situation) is more preponderant than its present value.
The third status when occurs that the inflation rate is identically tantamount to the bank interest rate, in this case, a point of no return (i.e., a breakeven point or no profit or loss point) appears/arises in the investing or depositing, but the breakeven point in investment(,itself,) additionally engenders an opportunity cost for the investor.
The fact is that the concept of future values of mazuma (money) is entirely predicated on interest rates and with the fad of interest rates in the economy, this concept withal becomes baseless.Today, due to the dictation of bank interest rates by central banks, the stability of all sensitive markets, (such as financial, capital, coins and precious metals, currency, housing, automobiles markets), and in general, any mazuma absorber markets becomes facilely fluctuate in some countries and any interest rate shock can facilely lead to market turbulence and economic instability.
Thus, key macroeconomic parameters of societies such as inflation, employment, investment and engenderment (/production)rates, etc. can be controlled and manipulated. This fact betokens that the source of the sundry financial, economic, contractual, law and licit (/legal) risks in today’s societies, i.e., the states are getting more vigorous.
Therefore, governments can easily affect economic efficiency.Consequently, regimes can facilely affect economic efficiency. Position-oriented (and not public-oriented) governments are simply and directly generating different economic rents and destructive risks to the internal and external trade of societies. Because this concrete planner inception of perils genuinely determines the calibers of returns (or profitability) rates in different activities and on the other hand, by defining regulatory principles, the licit bespeakers (the legal indicators) of the apperception of the economic activities of societies (such as the preclusion of buying and selling certain types of mazuma assets) are virtually moving towards engendering variants of economic rents and thus lowering the value of the national currency.
Due to the resultant of these factional (/position-orientedly) decisions, the range of risk, bank interest rate and return on various economic activities in long and medium term investments becomes highly volatile.
By stimulating liquidity on one sidedly basis, assets conversions and consequently the levels of supply and demand in markets which are sensitive to the rate of profit will extremely fluctuate and investor sentiment will change. Therefore, the consequences of position orientedly or one sidedly basis decisions and play with interest rate, Simply make the results of present value method faced with a variety of contradictions in the real world.
The first drawback of this method is that the discount rate (by compounding) for amounts received during the coming years(i.e. cash in), assumed to be unchanged while the rate of inflation over those years could be very different. Therefore, the results of the referred methods of assessment formed on the concept of present value (which is, itself, based on interest rates), can be very misleading and dangerous unless another indicator instead of interest rate is realistically taken into account to reflect inflation or recession effect in respective calculations.
Apart from interest rates, changes in any other assumptions used in each of the referred evaluation procedure can individually make the base of financial and economic calculations in the valuation of the investment idea meaningless. For example, let’s consider the amount estimated for an investment idea.
In the absence of economic stability with an increase in inflation rate (and in case of non- loss of income compensation to the owners of funds by rising interest rates) in some countries, the cash liquidity and deposits are rapidly withdrawn from the banking system and will be poured into other markets (whether legal or illegal).
Thus, the size of the false demand for the common items in the aforementioned markets increases sharply and this, quickly, results in the explosion of prices and the collapse of the national currency, which, of course, the consequences of such event on the estimated sums for plans (due to the devaluation of the national currency base and the collapse of its equality rate with the hard currencies), is completely predictable.In these circumstances, the estimated and budgeted sums or basically budgeting due to the devaluation of the money have appeared ridiculous. This means that the premise of calculating the internal rate of return or any other profitability index (i.e., the amount of investment), has a large deviation from the current costs of the day.
Therefore, all analyses and calculations made according to such common methods are appeared to be non – rigorous (/unprecise) and unreliable.In economic stability situation, prediction and calculation of the rate of return and its comparison with the expected return rate is assumed as a scale for decision – making.
Such scales, in powerful and stable economies such as the economy of some developed countries, as a measure for drawing the financial view of investment ideas, seem to be reasonable but, it should be noted that the aforesaid methods establish only a few simple parameters, such as repayment period or investment return period and profitability rate on presumptions basis.
Here, a few other vital parameters such as the ability to secure the required financial resources from different financial and capital markets, the value chain (i.e. the value chain of the idea of investment), etc. are ignored. Hence, to access a more detailed prospect of the idea of investment, feasibility study tool (in the technical, financial and economic, market, legal, political and social, beneficiaries of the project, Government and…) has been recommended.
But the feasibility study tool is also a tool based on assumptions and if any of the initial defaults change at the time of feasibility study (for example, new laws are enacted), other different results will be achieved. In fact, the efficiency of the feasibility tool also directly depends on the prevailing economic situation.
The more volatile the economy becomes, the lower the desire to undertake long – term investments in productive sectors, in such circumstances the funds are mainly focused on early productive sectors with short repayment period , such as the service sector (especially the brokerage, speculation, etc.). Therefore, it is clear that the initial defaults at the time of conducting the feasibility study will be meaningless. Hence, the basis of feasibility studies and the correct methods of doing it -should first beinvestigated, properly.
The economic situation and its effects on financial and economic analysesthe economic status of different communities directly affects the analysis and evaluation of investment ideas.In the economic stability situation where the resultant of various factors affecting on different markets, key indicator rates (such as inflation rate, the bank interest rate, the currencies exchange rate, the capital profitability rates in parallel markets), and liquidity mobility among the markets are in a state of relative equilibrium.
There is the possibility of determining the necessary assumptions for financial and economic calculations related to investment ideas within a limited time period. But even in this case also, the choice of interest rate for calculating the present value of estimated sums in cash flow of an investment idea, make the accuracy and integrity of the results achieved under questioning (or doubtful) because the bank interest rate is a rate that is not determined by the actual factors’ basis for demand and also supply of the legal currency in banking system.
This rate in different countries is not floating in real sense and it is usually dictated by central banks of mentioned countries and depending on influence of powerful groups in different markets such as manufacturers, factory owners, residential land owners, etc. pushes to be determined at the lowest level (and even in some countries, lower levels of inflation) in order to push the liquidity toward their interest and benefit by making false inflation.
In fact, except for a few countries with a stable economy depends on the factors of production, big or macro capital, skilled labor (and not merely literate), export diversification and a logical framework law for different markets, as well as a tax system intelligent, especially in the property/ real estate market and capital assets, the likelihood of continuation of the economy stability situation is higher because in these countries the opportunity cost in the general level of the economy is limited, but even in such countries, the choice of interest rate as the main parameter in calculating the present value of money, is not rational (logical).
So, to evaluate investment ideas should be more realistic methods to be used (or contracted). Therefore, it is reasonable if the present value of money concept is defined according to the percentage of decline (/ reduction) or increase in the purchasing power of money over the previous (/ past) years (i.e. by comparing current prices with the prices in previous years) and using a weighted average rate of return in the liquidity absorbent markets (to calculate the future value of money). In other words, it is logical that the concept of the present value of money is defined and calculated based on the past value of money (and not future value of it).
This is a new theory in financial management and capital management. It makes the foundations of the previous theory related to present value of nullBy the other, in defining and classifying the risk should also be more realistic. To carry out transactions, the risk must be also determined, calculated and evaluated. Risks in various economic situations i.e. economic stability or economic instability and the time period between these two situations are very different, but what is the correct way to calculate the risk?
Is the use of dispersion indices for expression and measurement of the risk is reasonable? Is it possible to make more logical methods used to contract? Apart from the rate of return / profitability, payback period and risk, other important parameters such as cost to each of the investment options, value chain of the different investment ideas and the durability of the product in the market need to be considered. For example, suppose there are two following ideas for car fuel supply:
A) Production of petrol using crude oil resources
B) Production of LPG , compressed natural gas (CNG), synthesis gas (SNG) using natural gas sources
The choice of each of the above scenarios in the country’s energy system will have a wide impact on the national economy. Cost and value chains of which fuel is preferable-Is the production of gasoline for cars in a country with huge gas reserves justifiable? Does gasoline work with more inflationary and price effects or natural gas? Sustainable economic growth and development through which fuels are secured and guaranteed: natural gas or petrol?
First parameter: The cost of any of the above investment ideas: The cost of gasoline production facilities (investment amount/ capital cost) and cost of required ingredients for the production of petrol(direct production expenses) + other expenses = production cost (For a certain production capacity). The cost of gas fuel production facilities for the vehicle (the amount of investment) and the cost of the ingredients for the production of the aforesaid fuels (direct production expenses) + other expenses = production cost (for a certain production capacity)
Second parameter: The value chain of each of the above investment ideas.
Third parameter: Calculating the rate of return of each above investment ideas by using the weighted average of profit rates in parallel markets and adjusting estimated costs based on inflation rate.
Fourth parameter: Calculating risk in any of the above investment ideas.
Fifth parameter: Calculate the payback period on any investment ideas above.
The sixth parameter: The future of the product and its market view……… Continues.
The above article is a brief section of the ‘ Book on new scientific theories ‘ in financial management and capital Management (along with a thorough description of the traditional theories)’which is being written by Masood Zohdi , the author of the large collection of series books in financial, accounting, economic and managerial methods asprudent in the international oil industry (out of it ,14 volumes of them published up to now) in both Persian and English and will soon be distributed in the market of professional books for experts.