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Determining if an Investment in and/or by a Privately Owned Company is Warranted
The Art of Investment - Deciding if money should be spent or invested in or by an entity.
San Diego, California USA - Recently while participating in a Board of Directors meeting of a privately owned company the issue of purchasing new equipment and other expansive moves was discussed and that prompted me to think generally about investment justification.
How does one decide if money should be spent or invested in or by an entity having both the money and alternatives? The art of all investment is, almost by definition, the awareness of alternatives having the same or less risk and the same or greater predictable return. Therefore, it is all a matter of relative returns and one of the critical measures must be the level of riskless return which is readily available to the owner of the money.
If so-called riskless return is reflected in the London Interbank Bank Offering Rate (LIBOR) then LIBOR can be used and predicted returns from actions incurring greater risk can be analyzed as to the merit of risk acceptance.
Does it not seem reasonable that an investment bearing any risk should have, at least, a conservatively projected return of 150% of LIBOR, which is so attainable without risk or organizational effort? Indeed, the level of required return should probably be significantly greater than LIBOR for any investment which is not of the highest quality and immediately marketable.
A result of using a factor such as LIBOR as a measure of acceptable return will be a discouragement of many investments as the differential between the LIBOR riskless and effortless return and that of the contemplated investment will not be sufficient to justify the risk acceptance. No one should make decisions in a vacuum and an awareness of alternatives is vital for optimal results.
This brings us to the need for a qualification of risk. All of life is an arbitrage and the successful investor/manager will understand the relative risk levels inherent in contemplated transactions. The investment in equipment which "pays for itself " in savings over the current practice in two years is a 41% annual average compound return versus a riskless return of say 6%. Such a disparity seems to me to be a highly satisfactory differential and I would vote for the expenditure.
The point of the above discussion is one of observing the need for disciplined decision making in the making of investments always bearing in mind the availability of riskless returns which have to be compared to whatever is being considered.
Author/Correspondent's Profile: Arthur Lipper III, Chairman, British Far East Holdings Ltd.
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