[MUSIC] In this class, we will focus on investment appraisal. So if we have an investment decision, the evaluation of the convenience or not to implement this investment should not be limited to the calculation of the net present value. But it should be also analyzed together with some qualitative analysis. Specifically we can identify five different steps if we want to evaluate an investment decisions. The first step is the identification of the alternatives. The second step is the verification of the consistency of each alternative. Then the third step is the identification of the boundaries for our alternatives. Then the third step is the analysis of the competitive impacts of our alternatives. While the last step is the quantitative analysis, so the calculation of the NPV. Given these five different steps, we can say that the first three steps are related to the analysis of the alternatives, while the last two steps are specifically focus on the analysis of the impacts of our alternatives. We are now going to discuss each of these steps. Let's start from the number one. The first step is the identification of the alternatives. If we are analyzing an investment, we need to identify which are the alternatives that we can have. And specifically we need to distinguish between a mandatory versus a non mandatory investment. If we have non mandatory investment, this means that we also have the possibility not to invest. And in this case, these decision of maintaining the status quo. So of not to invest represents what is defined as base cases. For example, if a company is evaluating the possibility of purchasing a new software, the company has also the possibility not to purchase the software. So our alternatives will be the decision not to purchase the software and the decision to purchase the software. And our alternative not to invest, so our alternative to maintain the status quo represent what is defined as a base case. So the reference level with respect to which we are going to analyze the effects of our decision. Pay attention because in this specific case, we need to keep in mind that even though the state our status quo will be the same, the net cash flow over time will decrease. And the reason why is because the external environment, so our competitors are evolving and are moving ahead. So basically even though we are not investing, we cannot think that our net cash flow will be the same over time. But it is very probably that our net cash flow without the investment will go down because of the external environment is evolving. The opposite situation instead is the moment in which we have mandatory investments. In this case, we can not consider the possibility to not invest because we are obliged to do the investment. In this case, these mandatory investment is the related to an economic perspective not to a legal one. For example, assuming that we have a new regulation that requires company to reduce the carbon emission. And our specific company in order to satisfy this requirement should change the equipment. The decision to purchase the equipment is a mandatory decision but not from a legal perspective because the company has the possibility not to do the investment. And in this case the company will stop its activity. So it is a mandatory from an economic perspective and not to a legal one. And pay attention because if you have mandatory investment given that you do not have let's say the status quo is an alternative. One of the possible alternatives of investment will be the base case. So the reference line with respect to which you are going to evaluate your investment, and that's the phase number one. So at this level, you have identify your possibilities. We can now move to the phase number two. And step number two is related to the analysis of the consistency of your alternative, which means that for each alternative you should be able to identify complementary projects. I'll give you an example, assuming that the company is evaluating the possibility of purchasing a new software. The main investment is the purchasing of the software, but of course, we need also for example to train people. So the cost for training people should be included in the evaluation of the cash outflow related to our investment decision. So we need let's say more in general to bundle together complementary products. So we need to include in the cash outflows related to the investment also projects which are not the main project, but that are complementary with respect to our investment. At the same time We should also do the opposite. We should like not to consider in our analysis those projects that can be independent and separated with respect to the measure one. So we need to unbundle independent projects. At this point, once we have identified basically the amount of our investment of our alternatives. We can move to the step number three, and the step number three is the identification of the organizational boundaries per each of our alternative. This means that we need to identify which are the organizational units that are affected the most by our investment. We can do this by doing an input-output analysis with respect to our activities. This means that we need to identify the activities that are going to change the most because of the investment. And given these activities, we need to identify the input and then the output for this activity. And the organizational units that will be responsible for providing the input and then for receiving the output will be the organizational units that will be affected the most by our investment. Again, if we maintain is an example the decision of our company to purchase a new software in order to pass from a paper-based to a web-based management of the expenses. We need to start from the activity of managing from a web-based perspective our expenses. And we can identify the organizational unit that are going to provide the input material to our main function. And then we charge the organizational unit that will receive the material that is generated by these web-based activity. So basically the organizational unit that provide the inputs and the outputs will be those organizational unit that will be influenced the most. And should be taken into account carefully in the management of this change of these implementation of the investment. At this point, we can move to the phase number four, which is the analysis of the competitive impacts of our alternatives. This means that for each of the alternative, we need to identify from a qualitative point of view the impact of this decision on the final generation of the net cash flow. If we want to do this, the value three could be particularly useful. The value three is an instrument in which we start from the so-called critical success factors that can be defined more in general as the internal or external driver of a company. And then starting from these drivers that are the levers through which the company wants to be successful with respect to the other competitors. By identifying these critical success factor, we identify how these critical success factors or these levels will impact on the components of the balance sheet and the income statement and finally on the net cash flow. For example, assuming that one of our lever is the decision to improve the quality of our products. So we want to improve let's say the service that our customers will receive. If we are improving the service quality, this means that it is very probably that our sales are going to increase. And if our sales increase, our revenue will increase and EBITDA will increase as well, arriving at the end as an increase of the net cash flow. In this case, we are acting on an external driver which is something that the customer can see. We can also act on internal drivers that can be activities and resources. For example, we can decide to manage the resources that we have an input in order to reduce the waste that we have. In this case, we will have less costs which means that at the same time the EBITDA will be higher and so the impact of the net cash flow will be positive. Of course, this analysis of revenues and costs and how they are going to change should be counter balanced by the analysis of the cash in and out because of the investment. Once we have analyzed the qualitative impact of our alternatives, we can now move to the step number five. And the step number five finally, we can calculate the net present value, so we can quantify in economic terms of specifically in terms of cash generated the impact of our alternatives. And so the decision, let's say the alternative that we are going to implement will be the alternative that is able to generate the higher net present value. [SOUND]
