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How does modelling help in deciding on an investment?

Helps to look at overall financial impact and obligations over investment period


How do you model the effects of debt and equity?

Firstly collate all required info, then build financial model to look at the financial obligations and potential returns

Sometimes ‘sensitivity analysis’ = helps to look at various scenarios /situations that could occur over a specified period and how this effects the IRR and NPV (i.e. if we change the time discount rate, how does this effect the IRR)?

Most common type of model = DCF, which looks at future / expected income and cost projections over set period and discounts them back to today to get a PV

Internal rate of return (IRR) = used to work out percentage return over period with assumed capital costs, income and discount rate

The NPV = today’s capital value of the cash flows after applying a required rate of return

Level of debt /leverage can have significant effect on outcome

When using IRR as performance measure, positive value addition along with leverage creates a higher return percentage than that of all equity

This is due to the investor being able to access positive returns with less of their own capital, i.e. making more money with putting less in

The counter to this is when negative values are experienced the downside is also amplified and further capital may be required to avoid foreclosure from the lender = greater risk


What is Modelling

Modelling = means of estimating the attractiveness of an investment