Showing posts with label investment decision. Show all posts
Showing posts with label investment decision. Show all posts

Wednesday 9 May 2018

The Hidden Traps in Decision Making

Making decisions is one of the most important things we do in our daily living.  It is also the toughest and riskiest in some situations.  Bad decisions can damage your career, business and finances, sometimes irreparably.



So where do bad decisions come from? 

In many cases, they can be traced back to the way the decisions were made:
  • the alternatives were not clearly defined,
  • the right information was not collected,
  • the costs and benefits were not accurately weighed.
But sometimes the fault lies not in the decision-making process but rather in the mind of the decision maker.  The way the human brain works can sabotage our decisions.



Psychological traps

There are a number of well-documented psychological traps that are particularly likely to undermine decision making.  These include:
  • heuristics#, 
  • biases and 
  • other irrational anomalies in our thinking.  


Your best defense is AWARENESS

There are specific ways you can guard against them.  However, the best defense is always awareness.  

By familiarizing yourself with these traps and the diverse forms they take, you will be better able to ensure that the decisions you make are sound and that the recommendations proposed by others (your subordinates or associates) are reliable.





Additional notes:

#heuristics:  
These are unconscious routines we use to cope with the complexity inherent in most decisions.  These routines serve us well in most situations.  These simple mental shortcuts help us to make the continuous stream of judgments required to navigate the world.  But, not all heuristics are foolproof.  The resulting decisions often pose few dangers for most of us, and can be safely ignore.  At times, the decisions arising from these heuristics can be catastrophic.  What make all these traps so dangerous is their invisibility.  Because they are hardwired into our thinking process, we fail to recognize them - even as we fall right into them.

Monday 10 April 2017

Investment Decisions

Some investment decisions are easy to make.

  • Perhaps, a government safety regulation makes an item of capital expenditure compulsory.
  • Or perhaps, an essential piece of machinery breaks down and just has to be replaced.
Many other investment decisions are not nearly so clear cut and hinge on whether the proposed expenditure will generate sufficient future cash savings to justify itself.

There are many very sophisticated techniques for aiding this decision.  Here are three techniques that are commonly used:

  • Payback
  • Return on investment
  • Discounted cash flow.

Payback
This has the merit of being extremely simple to calculate and understand.  It is a simple measure of the period of time taken for the savings made to equal the capital expenditure.

Return on investment
This takes the average of the money saved over the life of the asset and expresses it as a percentage of the original sum invested.

Discounted cash flow.
This technique takes account of the fact that money paid or received in the future is not as valuable as money paid or received now.  For this reason, it is considered superior to payback and to return on investment.  However, it is not as simple to calculate and understand.  Discounted cash flow involves bringing the future values back to its Net Present Value.

Sunday 6 December 2015

Investment Decisions and Fundamentals of Value




Investment Decision Rules:

Accept all investments with Net Present Value greater than Zero.

Accept all investments with Rates of Return greater than their Opportunity Costs of Capital





@ time 39.00

An example:

You are considering an investment opportunity that costs $100,000 and promises to return 10%.

A comparable investment in the financial market returns 15%.

A bank offers to lend you $100,000 at 8% with no conditions.


Questions:

1.  Do you invest $100,000 in the investment opportunity?

Answer:  NO

2.  What is the investment's cost of capital?

Answer:  15%.


Reasons:

You should invest the $100,000 in the financial market that returns 15%.

The financial market provides the investing return standards against which other investments are evaluated.

Financing by the bank loan at 8% was irrelevant to the investment decision.

The investment decision and the financing decision are separate and independent decisions.

After you have made the investment decision, thus:
You are considering an investment opportunity that costs $100,000 and promises to return 10%.

A comparable investment in the financial market returns 15%.

Then you make the financing decision, thus:
A bank offers to lend you $100,000 at 8% with no conditions.