When the economy suddenly has more money circulating around there is the threat of inflation. "The Federal Reserve is expected to hold its main short-term interest rate at a 45-year low of 1% at its last meeting of the year in December, as well as into part of 2004, economists predict. Holding short-term rates at such low levels might motivate consumers and businesses to spend and invest more, something that would lift economic growth." (Aversa)
The national debt crisis has required a new look at corporate America in regard to valuing the risks and returns of companies and instruments. Many investors apply the Warren Buffet philosophy. Buffett seems to believe that thorough analysis of each company, patient purchasing at the lowest possible price and holding for the long-term will weed out the dogs. Warren Buffet is one of the richest men in America with probably only Bill Gates ahead of him in overall wealth. "So businessmen like Warren Buffett, Bill Gates, Jeff Bezos of Amazon.com, Michael Dell, the founder of Dell Computers, Bernard Marcus and Arthur Blank of Home Depot, and mutual fund manager Michael Price have been lionized in the press. Each became a billionaire, or near billionaire, in the 1990s." (Gross, 2000) Therefore, the Buffett approach of investing in companies provides an excellent opportunity to reduce risk levels. The approach follows:
First do a thorough Background on the company. Evaluate brand recognition and types of companies considered a monopoly by consumers. The company must be able to adjust prices to meet inflation so it makes money irregardless of economic climate. The company should make products that are understood so you can comprehend the exact business of the company. Earnings must be predictable so any year's earnings per share (EPS) must be positive. Debt must be low. And finally, the Return on Equity (ROE) must be high and expenditures down.
An industry outlook: The industry should not be able to do a thing without first going through the company for example Coca-Cola, McDonald's, or American Express in their respective industries.
Once a company is identified, market price determines whether to invest in the company because initial price is very influential on the overall returns in the long run. There are three parts to section two: ROE method, EPS growth method and is to average both returns to create a final return.
Determine the per share growth rate and per share earnings for the past 5 yrs
Calculate the return of equity, PE ratio, rate of compounding and retained earnings
Include the future plans of company
Choose to buy/Pass
Another major valuation methodology for verifying the effects of debt on corporate America or individual companies both large and small would be to utilize the Return on Investment approach. The objective should always be to identify companies with quantifiable, reliable, and accurate measurements for the Return on Investment (ROI). The key to producing a credible ROI is ascertaining the hard cost and the revenue impact. Hard benefits can be measured and do affect the company's gain/loss statement. The best approach when verifying debt is to exclude soft benefits, which are operational benefits that cannot be easily quantified and audited and do not affect the company's gain/loss. Return on investment analysis is a crucial decision-making tool and can be used to evaluate the expected return of companies by comparing the size of an investment and the inherent timing of expected savings or increased revenue based on investments in the company. In this time of debt, this tool can be widely used to help guide decisions for purchases, investments, and improvements.
Return on investment is calculated as a "return" (incremental gain/reduction in costs) from an action, divided by the cost of that action. That is called simple ROI. For example, the ROI for a new machine that is expected to cost $250,000 over the next twelve months and deliver $1,000,000 in cost reduction over the same time is:
1,000,000-$250,000)]/$250,000*100 = 300%
As a ratio, the ROI is [the return]:[the investment].
When utilizing the approach for an investment. three data points are required:
The period -- typically this is one year.
The investment -- typically this includes any costs involved in implementing the project, such as the cost of labor, professional services, and maintenance over the period of interest. It also includes costs such as training, development, other professional services, and additional systems, software, hardware and licenses that may be required.
The return -- this is the sum of the cost savings and revenue enhancements gained from the project.
There are three ways to calculate the ROI:
As a percentage -- if you gain benefits equal to $1,000,000 in 12 months on a total investment of $250,000 in the same time period, the ROI can be calculated as follows:
If, Return = Payback - Investment
ROI = [(Payback - Investment)/Investment)]*100, or in this case: [($1,000,000-$250,000)/$250,000]*100 = 300%
2. As a ratio -- divide the return by the investment.
1,000,000/$250,000 = 4:1
3. As a time to break-even; determine the number of days, weeks, or months it will take to break even on the investment.
Time period to break-even = (Investment/Return)*Time Period
250,000/$1,000,000)*12 months = (0.25)*12 = 3 months or 90 days
ROI analysis is one of several financial measurement tools that can be used to support an investment decision. However, it does not factor in risk and it does not do a good job of accounting for intangible rewards.
In conclusion, this report was a two part report that focused on the general topic of the United States of America's national debt crisis. The first part of the report attempted to provide insights into the causes and affects of the debt as well as identifying some large and small companies that are most affected. In many cases, the governmental budgeting crisis went as far as causing failures for some of these companies. The second part of the report aimed to discuss the risks and valuations of companies and instruments as well as risk and valuation methodologies that have been developed with respect to the debt situation. The focus of these methodologies will be related to the debt market, investment banking and the secondary mortgage market, valuing the risks and returns of the companies and instruments involved. The research attempted to present an extensive discussion regarding methods of valuation.
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Buffet. (2004). "Berkshire Hathaway Inc." Retrieved on December 5, 2004, at http://www.berkshirehathaway.com/letters/letters.html
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