Net present value and payback analysis for small business financing decisions

¶ … pay back period" is the length of time that is required to cover the cost of an investment. I would use this in order to make a good financial decision.

The calculation that I would do is as follows:

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For instance, if a project costs $100,000 and is expected to return $20,000 annually, the payback period will be $100,000 / $20,000, or, in other words, $20 per 5 years.

The better investment is the one that has the shorter pay back period.(Investopeida)

Another tool that I would use to measure the time value of money to assess long-term projects is Net present value (NPV). Businesses use it to measure the value of a time series of cash flows both incoming and outgoing. For instance, when all types of cash flows are incoming (such as bonds or coupons), and the only cash outflow is the purchase price, the NPV is the present value of future cash flows minus the purchase price (which has its own present value).

NPV measures the amount of cashflow once financing charges are met.

I would calculate NPV by taking the input of a series of cash flows as well as considering a discount rate or curve, and the output is the price.

Advantages and disadvantages of debt financing

Some people consider debt financing in order to start a business. This will help them avoid investors so that they can run and own the business themselves making decisions independently of others who have vested interest in business.

The advantages of debt financing are the following:

Owner can make decisions independently of others and is responsible for own business. He alone keeps profits

The interest that business owner pays on loan is tax-deductible which means that his tax liability is lowered every year. His interest is usually based on the prime interest rate.

He does not need to share profits with lender of money. All that is required is that he repays loans in timely manner.

Business owner may be applicable for Small Business Administration loan. This kind of loan has more favorable terms than one that he would request form a bank.

Disadvantages of debt financing

The expense may be enormous. Preciously when the business needs funds for start-up costs, he has to regularly pay back loans.

if repayment is not made in timely fashion, his credit report rating suffers and he may find it more difficult in future to gain loans.

The stress to repay loans in timely fashion may impact various areas of his life (such as family and social) aside from business.

A new business may be required by commercial banks to also pledge personal assets. Bankruptcy of business invites loss of personal assets.(About.com )

An organization would usually choose to issue stocks rather than bonds to generate funds. This is because factors of production (i.e. bonds) such as land and capital are usually scarce and expensive. Were the company to use bonds, they would therefore have far less resources at hand to generate funds.

Stocks o the other hand are a security that represent a potential or current investor's part in benefiting from the profits of a business. It represents a person's share of ownership in a company as well as a claim on the company's assets and revenues.( ehow.com )

how financial returns are related to risk

It is impossible to realize a return on any investment without taking a certain amount of risk. This means that the return on the investment may fluctuate, or may ultimately not return profit. One may think that keeping one's money in savings is safer, but then one constrains oneself from possibly receiving future reward.

The concept of beta and how it is used.

Beta is a measure of the risk of a stock and how it relates to the market as a whole. In other words, it is a guideline of the stock's value in relation to the market based on the assessed data of the stock and the market. A beta of 1 for instance means that the stock is less volatile than the market, whilst a beta that exceeds 1 means that the stock is more volatile than the market. The beta may have periods of volatility that are higher or lower than expected.

Low beta stocks include resale / wholesale food; electric utility; educational services;a nd tobacco.

High beta stocks include semiconductor equipment; hospitality / hotel / gaming; private equity / financial services; and metal fabricating.

Low beta stocks are considered more stable and will show gains when the market is appreciating. Furthermore, when the market is dropping low beta stocks experience less of a drop and the investor will be in a better position than had he invested in riskier stocks.

However, since these gains are less than the market as a whole the investor will be better off investing in high beta stock particularly since these types of stocks rise more rapidly than the market. However if he invests in high beta stocks that have potentially higher returns, his losses may be just as great. In other words, the high beta measures come accompanied with higher risks whilst low beta stocks are stable but offer low reward (Benzinga. Com )

systematic and unsystematic risk

Systematic risk are risk factors that affect the entire market such as investment policy changes, foreign investment policy, change in taxation clauses, shift in socio-economic parameters, global security threats and measures and so forth.

Unsystematic risk, on the other hand, are risk factors inherent in an industry or company such as labor unions, product category, research and development, pricing, marketing strategy .

Systematic risk is beyond the control of investors and little can be done to predict or do anything about it. Unsystematic risk on the other hand can be avoided by carefully assessing organizations and deciding which to select. One can also diversify one's portfolio deciding how much to invest in particular organizations dependent on their unsystematic risk value.

Another difference is that whilst the market does not compensate for taking unsystematic risks, the market often does compensate for taking systematic risks. The greater therefore the systematic risk, the greater therefore is the expected rate of return from the asset. (Cuckke.com.)

Recommendations for investing money in order to diversify the risk and receive a good return

One of the best pieces of advice is to go for variety not quantity. In other words, one should have a lot of different kinds of investments and this includes stocks, bonds, real estate funds, international securities, and cash. Stocks help the portofolio grow. Bonds bring in income. Real estate may rise when stocks fall; international investments provide growth and buying power; whilst cash gives security and stability.