Financial distress is a situation in which a company cannot meet its obligations. In fact, companies borrow debts from investors for operations and growth. When the company performs badly, it may be unable to repay back the loans and funds it has borrowed from the lenders. This is called financial distress of the company.There are many costs attached to financial distress. These may include costs related to employees, managers, customers, suppliers, and shareholders.Costs Related to EmployeesThe employees of a distressed company are not confident. They are demoralized and worried about their future. This affects the quality of the products. The ... Read More

To better understand the two concepts of risk-adjusted and certainty equivalent methods, let’s understand what they mean and how they are useful for investors.What is Risk-Adjusted Discount RateThe risk-adjusted method combines an expected risk premium with a risk-free rate to calculate the present value of an investment.Risky investments include investments in real estate and other high-level risk projects. Although the market rate is considered as the discount rate, in some cases, a risk-adjusted rate for the investments becomes crucial for the investors.The risk-adjusted discount rate method correlates risks and returns while signifying the requisite returns of an investment. This means ... Read More

Sensitivity AnalysisSensitivity analysis is a financial tool to analyze the effect of a set of independent variables on a specific dependent variable under some given conditions. It is used in a wide range of applications, such as in biology and finance as well as economics.The sensitivity analysis studies numerous sources of uncertainty that contribute to the forecast’s uncertainty by using what-if queries altogether. It is used within limited boundaries that rely on one or more inputs.How Does It Work?Also known as What-if analysis or simulation analysis, sensitivity analysis helps to ascertain some decisions depending on numerous independent variables.For example, it ... Read More

Inflation is the rise of prices of daily usable goods such as food, clothing, fuel, transport, etc. Inflation increases the cost of living. It can also be considered as the change in the average price of services and commodities at regular intervals. It indicates the losing value of purchasing power of a unit of a nation’s currency as the services and products get more expensive.In general, inflation is the difference between the demand and supply of a good or service. When aggregate demand exceeds aggregate supply an increase in price level takes place.Although high levels of inflation are unwanted, a ... Read More

Probability is the likelihood of an event to occur. It is impossible to guess some events whether will occur with 100% certainty and hence the use of the theory of probability is important. It tells us the certainty of an event to occur and how and why it will occur. Probability is an important theory in finance because most of the calculations in finance occur in the future for which probabilities of their occurrence are important to consider.Depending on the nature of calculation or determination, there are two types of probabilities. The one that uses history and data is known ... Read More

Product cannibalization is the process in which a new project or product eats away the cash flows earned by an already existing product. That means, when a new project or product is launched, it may take the cash flow away from an already running product or project. Business decisions must include the cannibalization effect into consideration because ignoring this may lead to huge losses sometimes.Capital budgeting decisions are taken keeping profitability and market share of products and they should include a holistic approach.A new product or project must not negatively impact an already available product or project which is running ... Read More

What is Terminal Value?Terminal value or horizon value is an important metric for forecasting future cash flow. Generally, the terminal value represents the present value of a future cash flow taking the growth as a common rate of perpetuity.There are many uses of terminal value but the most prominent use of terminal value is found in calculating the discounted cash flow (DCF). So, the terminal value is of vital importance for anyone who needs to do a DCF calculation.Significance of Terminal ValueAs is obvious, calculating a future value of anything with 100% accuracy is a challenging task. This is more ... Read More

Capital budgeting is one of the most important processes businesses need to rely on for growth and profitability. Therefore, careful insight and examination must be applied to the process of capital budgeting in order to get the most out of the process.Capital budgeting can be broadly categorized into the following five steps.Identification of Investment OpportunitiesThe first step of a capital budgeting process is the identification of an investment option. The business considering capital budgeting must find the reason for investment in this step.The identification may result in a number of ways, such as new product launches or expansion of the ... Read More

Interest rates are a very important part of the investment process, and investors usually invest their money depending on the interest rates. It is impossible to think about investment without considering interest rates. There are mainly two types of interest rates which the investors are concerned with. These are −Nominal Interest RateReal Interest RateLet’s consider the definitions of each one of the interest rates and then find out the differences between the two.Nominal Interest RateThe nominal interest rate is the rate an investor has to pay in the market without considering the rate of inflation. For example, the rates of ... Read More

The payback method, certainty equivalent method, and scenario analysis help investors to find one simple solution for investment analysis. However, for businesses, it is important that they keep making decisions one after another depending on the market conditions. That is, it is wrong to believe that only one analysis is enough and the end of the decision-making process. In fact, one decision leads to a sequence of other decisions and the process goes on in a manner in which decisions have to be taken one after another. Such a continuous decision-making process is known as sequential investment decisions.Why sequential investment ... Read More