When dealing with decisions using Cost Benefit techniques it is very important to follow the proven principles. The health of your company and your reputation depend on it. If these rules are not followed then your decisions could be flawed.
Let's start, shall we?
Benefit #1. You can compare competing projects quickly and accurately - saving you time and effort.
Cost Benefit Analysis weighs the total expected costs and compares them to the total expected benefits of one or more actions. The outcome of Cost Benefit Analysis is a Benefit Cost Ratio that is used to compare and rank competing investment options.
Once you apply these techniques you will quickly be able to compare and rank projects with confidence knowing that governments and large corporations use these proven principles.
Benefit #2. You can quickly determine whether a project may be VIABLE or UNVIABLE - quickly cutting out unviable options thereby saving you time and effort.
As mentioned above, Cost Benefit Analysis compares the costs and benefits of competing projects and produces a score (Benefit Cost Ratio) which if less than 1 shows that the project is UNVIABLE (all other things being equal).
This can quickly weed out the projects that will not make the cut, saving time and effort for you and others charged with considering these projects and making a final recommendation.
Benefit #3. You will be noticed and you will gain increased recognition if you use this technique correctly - more opportunities for you.
Since this powerful, proven technique can save discussion time, provide more accuracy and confidence, it will be seen as a real improvement. If you champion its introduction you will be noticed and gain recognition.
Benefit #4. You will be able to more confidently join or lead asset expenditure review discussions - more recognition and opportunities for you.
Once you learn and apply this method you can join in discussions at higher levels and feel confident that your skills can add value to the deliberations. Your input will be recognised and appreciated.
Benefit #5. Learning this very marketable technique will provide you with more options in your future.
There are many ways you can apply these techniques.
You could train others in the skill - both to internal and also to external clients.
You could be the assessor of the methodology PRIOR to projects being reviewed by senior management. This will save them time and frustration if they know that someone knowledgeable has already OK'd the maths and reviewed the assumptions for reasonableness.
You may wish to apply for more senior roles in your current employment or try out in other companies.
Benefit #6. You can apply these skills across small to large projects - making you more versatile.
The Cost Benefit principles can be used for projects as small as a PC replacement to underground assets that form part of large multi-billion capital works programs.
Your Cost Benefit Analysis skills are just as useful at either end of the scale.
Benefit #7. You will become recognised as the authority on this subject - more options for you.
Once you learn the theory and can present your proposal with confidence you will be recognised as the authority on this subject. Others will come to you for assistance seeking guidance for their projects.
Benefit #8. You can be sure that your decisions can withstand external scrutiny - saving you worry and concern.
The principles underpinning Cost Benefit Analysis have been in use since the 1960s by both government and big business. As long as you learn these principles from a recognised source, and apply them correctly, you can be confident that your analysis can withstand internal and external scrutiny.
Benefit #9. This methodology is scalable across small to large businesses.
Successful implementation across the business can only add to your marketable skill set meaning more opportunities for you. This skill could lead to consulting work for external clients - be they large or small - or starting your own Cost Benefit consulting business.
Benefit #10. Once this methodology is implemented it can significantly reduce the time taken to decide on competing projects -saving you time and frustration.
If this method is implemented for all investment proposals across the company then the comparison and choice amongst competing proposals is simplified. All other things being equal the project with the highest Benefit Cost Ratio should be the first to be authorised. The value of the business will increase the most by implementing the project with the highest Benefit Cost Ratio.
About the Author:
Bruce Hokin is an experienced accountant (FCPA). His main interests are in better decision-making and Cost Benefit Analysis training. You can find more of his in-depth FREE articles, a FREE Newsletter and FREE e-zines at his website. To sign up for his comprehensive, downloadable Cost Benefit Analysis training program "5 Steps to Cost Benefit Mastery" just go to his website. You could be using this technique in under 2 hours! Available at
http://www.thecostbenefitcoach.com/
Lender finance is an all encompassing area that incorporates all areas of capitalization for small and medium-sized finance companies. Many don’t realize that finance companies aren’t simply endless pools of capital that can make loans and leases however they see fit. Finance companies themselves are often in a careful balancing act between the loans they make and the debt and equity that they take on in order to make them. When a finance company formulates a solid capitalization strategy, it is able to create quicker and more sustainable growth.
Approaching lender finance, one often looks at equity strategies first. Many smaller finance companies will rely upon equity placed directly in the company by principals and small individual private investors. Larger finance companies can begin using strategies that involve raising capital from institutional investment groups, hedge fund of funds, and in some cases even public markets. Capitalizing through equity can present several challenges such as locating the right group who is willing to make the investment despite their lower gross rates of return and securing the capital fast enough to keep pace with loan demand.
This leads into the second strategy that finance companies use, debt capitalization. Finance companies often will seek debt capital because it is obtained more quickly and because groups willing to provide it are more readily at hand. Debt capital is usually provided in the form of a line of credit that the company can draw upon as it makes its loans. Some of these facilities are warehouse lines that can be used on a short-term basis before loans must be purchased by investors. Others are senior-secured credit facilities that the company can use to harbor loans on an indefinite basis as long as the loans maintain eligibility requirements. With both of these types of credit facilities, the company must maintain an equity margin between 10% - 20% on each loan that it makes.
On January 1, 2006, a leading financial daily reported the trailing 1-year and 5-year returns of Fidelity Contrafund (Nasdaq: FCNTX), a no-load mutual fund, as 16.23% and 6.21% respectively. While the financial daily's return information is useful, there is more to mutual fund returns.
Is the performance of the fund superior or inferior?
How tax-efficient is the fund in delivering these returns?
Are the returns of the fund commensurate with the risk the fund manager has taken to achieve them?
Savvy investors will seek answers to such questions when evaluating mutual fund returns. Before getting into the nitty-gritty of mutual fund returns, it is good to understand what the data reported in the financial daily really mean.
Total Return
Fidelity Contra's reported 16.23% 1-year return is the fund's total return for the December 31, 2004 to December 31, 2005 period. In practical terms, $10,000 invested in the fund on December 31, 2004 is worth $11,623 on December 31, 2005. The total return includes more than the increase (or decrease) in the fund's share price. It also assumes reinvestment of all dividends as well as short- and long-term capital gain distributions into the fund at the price at which each distribution is made.
Compound Annual Return
The reported 6.21% 5-year return is the fund's compound annual return (also called the average annual return). The compound annual return is a calculated number that describes the rate at which the investment has grown assuming uniform year-over-year growth during the 5-year period.
A $10,000 investment in the Contrafund on December 31, 2000 has grown to $13,515.34 on December 31, 2005. The ending value of $13,515.34 = $10,000[(1 + 0.0621)^5] where 6.21% is the compound annual return. The investment in the fund grew at an implied annual growth rate of 6.21% over the 5-year period.
While total return and compound annual return are useful, they do not tell how a particular mutual fund has performed compared to its peers. They also do not provide information on the return actually earned by investors after accounting for taxes. Finally, they do not offer insight on how well the fund manager has managed risk while achieving the returns.
Relative Return
Relative return compares the performance of a mutual fund against its peers. It is the difference between the total return of the fund and the total return of an appropriate benchmark over the same period.
Fidelity Contra is a large-cap growth fund that primarily invests in U.S.-based companies. It is therefore appropriate to compare its performance with that of an average large-cap growth fund. It is also relevant to benchmark the fund against the Standard & Poor's (S&P) 500 index, comprising of large U.S.-based companies.
While Fidelity Contra has a compound annual return of 6.21% for the 5-year period ending December 31, 2005, Morningstar reports the average large-cap growth fund has an average annual loss of 8.48% over the same period. The S&P 500 index has an average annual return of 0.54% over the same period. Fidelity Contra has outperformed with a relative return of 14.69% over the average large-cap growth fund and with a relative return of 5.67% over an S&P 500 index fund.
After-Tax Return
Unlike assets held in qualified accounts such as 401k plans or individual retirement accounts (IRA), assets held in regular individual or joint accounts are not tax-deferred. For such non-qualified accounts, after-tax return is the return realized after accounting for taxes.
Short-term capital gains and short-term capital gain distributions from a mutual fund are currently taxed at the same rate as earned income. Dividends, long-term capital gain distributions and long-term capital gains realized from the sale of fund shares are currently taxed at a lower rate.
Fidelity states the compound annual return for Fidelity Contra before taxes is 6.21% for the 5-year period ending on December 31, 2005. When all distributions are taxed at the respective maximum possible federal income-tax rate, the after-tax return dips to 6.10%. The after-tax return drops further to 5.33% after accounting for the long-term capital gain tax due on sale of the fund shares.
Risk-Adjusted Return
Some fund managers take more risk than others. It is important to assess a fund's return in light of the amount of risk the fund manager takes to deliver that return.
Risk-Adjusted Return is commonly measured using the Sharpe Ratio. The ratio is calculated using the formula (mutual fund return - risk free return)/standard deviation of mutual fund return. The higher the Sharpe ratio, the better is the fund's return per unit risk.
Based on returns for the 3-year period ending on November 30, 2005, Morningstar reports Fidelity Contra's Sharpe ratio as 1.74. The fund's Sharpe Ratio may be compared with those of similar funds to determine how the fund's risk-adjusted return compares with those of its peers.
Beyond Mutual Funds
Return concepts such as relative return, after-tax return, and risk-adjusted return may also be used for evaluating separately-managed accounts, hedge funds and investment newsletter model portfolios.
The AlphaProfit Sector Investors' Newsletter, for example, tracks the total return and compounded annual return of its Core and Focus model portfolios. To provide Subscribers with a more complete picture of model portfolio returns, this newsletter also tracks the relative and risk-adjusted returns of the model portfolios. The newsletter's model portfolios are constructed and repositioned with a view to maximizing after-tax returns.
Summary
While total return and compound annual return are useful, they do not provide a complete picture of a mutual fund's performance. Metrics such as relative return and after-tax return offer insights on the fund's relative performance and tax-efficiency. Risk-adjusted returns enable investors to assess how a fund's returns stack up when risk is factored in.
Notes: This report is for information purposes only. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice. This report does not have regard to the specific investment objectives, financial situation, and particular needs of any specific person who may receive this report. The information contained in this report is obtained from various sources believed to be accurate and is provided without warranties of any kind. AlphaProfit Investments, LLC does not represent that this information, including any third party information, is accurate or complete and it should not be relied upon as such. AlphaProfit Investments, LLC is not responsible for any errors or omissions herein. Opinions expressed herein reflect the opinion of AlphaProfit Investments, LLC and are subject to change without notice. AlphaProfit Investments, LLC disclaims any liability for any direct or incidental loss incurred by applying any of the information in this report. The third-party trademarks or service marks appearing within this report are the property of their respective owners. All other trademarks appearing herein are the property of AlphaProfit Investments, LLC. Owners and employees of AlphaProfit Investments, LLC for their own accounts invest in the Fidelity Mutual Funds included in the AlphaProfit Core and Focus model portfolios. AlphaProfit Investments, LLC neither is associated with nor receives any compensation from Fidelity Investments or other mutual fund companies mentioned in this report. Past performance is neither an indication of nor a guarantee for future results.
Author Bio
Sam Subramanian, Ph.D, MBA is Managing Principal of AlphaProfit Investments, LLC. He edits the AlphaProfit Sector Investors' NewsletterTM. The investment newsletter is ranked #1 by Hulbert Financial Digest. As of December 31, 2005, the investment newsletter's model portfolios have gained up to 87.8% since start of publication on September 30, 2003. The Dow Jones Wilshire 5000 index has gained 34.6% during the same period. To learn more about the newsletter, visit
www.alphaprofit.com.
One of my loyal readers from Private Equity Intelligence recently asked my thoughts about an article in his company's newsletter. I have been approached by his company several times for information about our funds. While I have always declined to dislose this information, I thought I would give them a plug for their efforts and because I do enjoy reading their newsletter from time to time.
Before I begin, I will first say that I do not use products from companies such as PEI. I think that they can help a fund get new limited partners and better market themselves in a competitive fundraising environment. However, at our funds, we only take on limited partners from existing relationships. We do not actively seek new investors, rather we take on people that come to us from prior relationships. We have always felt that this creates a stronger family of partners that is less litigious and into private equity for the long haul.
Now, back to the topic, one article from PEI's Spotlight Newsletter in their September issue highlights the fact that many LPs cannot meet their allocations to private equity. What this reveals is what many people don't know - that the largest pension funds are flush with cash and looking to put money to work. All it takes is the right set of connections, right marketing people, and the right management pedigree to raise a large amount of money very quickly. Some great managers have literally been able to get commitments of several hundred million in a few weeks. In these lift-outs from managers of already established firms, there is a clear correlation between amount of funds raised and the track record of the newly independent manager.
The main problem for these large investors is that they cannot find enough good deals to accomodate their need for large allocations. There simply are not enough good mega-fund managers. You could list probably 10 firms that can raise $10B plus worldwide. In the buyout world, there really are not enough managers with expertise in handling even a $1B plus fund.
If you think about it, there are very good reasons for this. The lineage of buyout funds can only be traced back thirty years or so. So every good manager has lineage from that small handful of early buyout pioneers. In every other sector of private equity other than buyout and real estate, it is especially difficult for managers to handle large sums. The venture investor is terrible with a $1B plus fund because large early valuations do not scale well with small startups. Similarly, the hedge investor has trouble placing these huge bets because so much leverage is involved and they would undoubtedly manipulate the market with that much flow.
Some people say that the breakneck pace of fundraising cannot continue and that someday soon the private equity party will end. As you can see, this is not true. The capacity of pension funds to fund private equity is underestimated. There will always be hungry investors with an appetite for private equity - that is because these investments drive most of their pension returns.
From James Chen's Pure VC Blog
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