Facilitator:
Fundamentals of investing
Investments involve making a choice among the available alternatives to adopt the best option that would yield ultimate returns for the capital invested. Capital budgeting involves different methods that investors use in evaluating opportunities available in the market and choosing the best place to invest. The most essential stage in the investment process encompasses determining the risk and return of different ventures and investing in the most promising venture (Hartwig, 2012). Different methods apply in the determination of the risk and return in standalone investment assets. This includes measuring of historical rates of return, expected rates of return, and the risk of expected rates of return. This paper compares and contrasts the three methods of measuring the risk and returns in a standalone investment asset with the view of getting the best methods that applies in the investment field.
The measure of historical rates of return differs from the other methods because, unlike other approaches that deal with the future rates of return, it deals with the past. The methods deals with the past meaning that the information used in forecasting on returns are more accurate than the information used in the other methods (Burns & Walker, 2009). This implies that the method uses more material facts compared to other strategies thus the information forecasted relies on facts that the business has experienced before at some stage. However, compared to the other methods, the historical rate of return method may lack important information about the future because, chances favour some microeconomic changes to occur in the future like inflation and tax adjustments that may miss in the past information.
Measuring the risk of expected rates of return differs from other methods in the sense that, as much as the historical rate of return and the expected rate of return deal with the actual returns only, measuring the risk of expected rates of return evaluates the risks involved with the returns. Measuring the risk of expected rates of return is effective because it helps investors to establish dangers of going for returns that a certain project presents before undertaking it. This may touch on the costs involved, which may appear higher than the actual benefits. The method roves disadvantageous compared to other methods because it is unable to work independently. The methods rely on the others because it gives the risk only, which may bother the investors, as they want to know the real returns on the business.
Measuring the expected rates of return differs from other methods in the sense that, unlike the other methods, it evaluates the real returns that the investor may expect from the project that they wish to venture. This methods appeal to most of the investors because they can forecast the returns from all the businesses and choose the best venture for their investments (Jack, 2006). However, the method may not function independently as the investor may desire to know the risks involved with the venture despite the returns promised, which involves measuring the risk of expected rates of return method.
The three methods resemble each other in the sense that all of them help the investor to establish and decide the best investment to undertake from a pool of the available opportunities. However, the methods depend on each other because the investor needs to have information about the past, the present, the future, and the risk involved in all the ventures.
References
Burns, R. M., & Walker, J. (2009). Capital budgeting surveys: The future is now. Journal of Applied Finance, 19(1), 78-90. Retrieved from http://search.proquest.com/docview/201488717?accountid=45049
Hartwig, F. (2012). The use of capital budgeting and cost of capital estimation methods in swedish-listed companies. Journal of Applied Business Research, 28(6), 1451-1476. Retrieved from http://search.proquest.com/docview/1221279369?accountid=45049
Jack and, S. W. (2006, Jun 26). Stop the B.S. budgets. Business Week,114. Retrieved from http://search.proquest.com/docview/236740717?accountid=45049
