Thursday, December 10, 2009
Finance and Human behaviour
Many people believe that people react in similar manner to a given information set and that is why they attribute many things like existence of financial derivatives and stock market variations to Information asymmetry. I remember somebody saying once that if everybody has same information the index will be flat. But One more important factor to be considered is reaction of people to any given information set. Different people will react to same information differently. And that is where finance can be related to streams like psychology and other theories related to human behavior. One interesting thing that can be done is to make some space for human behaviour in mathematical equations. Some days ago I was looking at weighted average cost of capital equation and tried to analyze sensitivity of various factors mathematically and then tried to look for various places where we could incorporate Human behavior. I was not able to do a proper justice to this exercise because of my lack of understanding of various factors but I found this exercise interesting. I searched internet for the same and got to know that a lot of research is going on in this area. I hope we will reach some conclusions soon. I remembered comment of one of my profs who says if you and I could predict human behavior we could spend rest of our life at Bahamas.
Tuesday, November 10, 2009
Is Entrepreneurship a good Idea for you?
In Financial language it is said that while we are evaluating a project we should try to evaluate it in terms of its Net Present Value. A thumb rule is that for an investment project if NPV >0, we should go for the project. Is we try to describe NVP in simple terms: It is the amount by which one gets richer today by investing in a project. Other definition could be: It is the present value of all the cash flows from the project.
Let us assume that we have invested 100 Rs. in a business and we get 50 Rs. from business after first year and 50 Rs. After second year. Let us assume that rate of return that we desire from the project is 10%, then the Present value of project is ( -100 + 50/1.1 + 50/1.21), which is negative, so we should not invest in this project. Had the second year cash flow been 70 Rs. instead of 50 rs. then the total present value of all the cash flows would have been positive. So by investing in the project I would have been richer today itself.
Well, Even if you are not able to understand everything completely, in other terms we can say that NPV of a project shows how we see our future returns from a project today. Lets apply this concept to Entrepreneurship. Many of us want to become Entrepreneurs but always face the dilemma if we should quit our jobs for an entrepreneurial venture?
Let us say one person is earning 12 lacs rupees in a year. This person gets an annual salary increment of 10% let us say every year. This person is investing an amount X in to an Entrepreneurial venture. The consideration period for business in let us say 10 years. This means that in 10 years time the business opportunity would be exhausted. Let us say that desired rate of return for person is 15% on the money that he is investing. Let us assume that person gets a 30% return on initial investment every year for 10 years. so your net present cash flow of future cash flow of any year would be ( [[[-1200000*(1.1)^n]+(0.30x)]/(1.15)^n]
If we calculate submission of values for all 10 years we would find that the x should be atleast 61 lacs to get a positive Net present value.
For somebody who does not want to get in to this calculation, he can understand that if a person leaves his 1200000 rs. per annum job to invest in a business that gives him 30% return on Initial investment every year (which is a significant quantity), he would only be richer by his entrepreneurial venture if his initial investment was more than 61 lacs. Other situation could be that the returns from business are very high and increasing.
My conclusion of this analysis is that it makes sense to leave your job for entrepreneurship only if you have an enormous initial corpus to invest or you have a really brilliant idea which gives you enormous returns. In all other situations, I would say Entrepreneurship can be kept just as a hobby. ( I mean not just as a hobby but something that should be pursued alongside your regular job)
So have a look at the analysis and think before you quit your job for your own entrepreneurial venture.
Let us assume that we have invested 100 Rs. in a business and we get 50 Rs. from business after first year and 50 Rs. After second year. Let us assume that rate of return that we desire from the project is 10%, then the Present value of project is ( -100 + 50/1.1 + 50/1.21), which is negative, so we should not invest in this project. Had the second year cash flow been 70 Rs. instead of 50 rs. then the total present value of all the cash flows would have been positive. So by investing in the project I would have been richer today itself.
Well, Even if you are not able to understand everything completely, in other terms we can say that NPV of a project shows how we see our future returns from a project today. Lets apply this concept to Entrepreneurship. Many of us want to become Entrepreneurs but always face the dilemma if we should quit our jobs for an entrepreneurial venture?
Let us say one person is earning 12 lacs rupees in a year. This person gets an annual salary increment of 10% let us say every year. This person is investing an amount X in to an Entrepreneurial venture. The consideration period for business in let us say 10 years. This means that in 10 years time the business opportunity would be exhausted. Let us say that desired rate of return for person is 15% on the money that he is investing. Let us assume that person gets a 30% return on initial investment every year for 10 years. so your net present cash flow of future cash flow of any year would be ( [[[-1200000*(1.1)^n]+(0.30x)]/(1.15)^n]
If we calculate submission of values for all 10 years we would find that the x should be atleast 61 lacs to get a positive Net present value.
For somebody who does not want to get in to this calculation, he can understand that if a person leaves his 1200000 rs. per annum job to invest in a business that gives him 30% return on Initial investment every year (which is a significant quantity), he would only be richer by his entrepreneurial venture if his initial investment was more than 61 lacs. Other situation could be that the returns from business are very high and increasing.
My conclusion of this analysis is that it makes sense to leave your job for entrepreneurship only if you have an enormous initial corpus to invest or you have a really brilliant idea which gives you enormous returns. In all other situations, I would say Entrepreneurship can be kept just as a hobby. ( I mean not just as a hobby but something that should be pursued alongside your regular job)
So have a look at the analysis and think before you quit your job for your own entrepreneurial venture.
Sunday, November 8, 2009
India in transition and new business opportunities
India is a fast developing country and Indian society is in its transition face. Our cultural values, social structure are changing with growing economic development. An important thing to notice here that we are following western countries in many ways and the process is still incomplete.
This transition is taking place in every aspect of life. Our lifestyles are changing. And this changing lifestyle calls for a lot of new products which will suit this change and will create value for us by helping us to adapt with this change. For instance our traditional families had a family security net. But with growing number of nuclear families a whole BIG BUSINESS OPPORTUNITY in terms of various kinds of insurances have opened up.
In some European countries Government provides a huge security net and in US everybody is ensured with various insurances. On the other hand in India there is a huge section of people for which thinks that insurances are wastage of money. They are not aware about possible kinds of insurances and they do not directly realize the need for these insurances. For instance a family may be spending 500 rupees per month on health expenditure without even knowing this. If they are made to realize that they are spending so much money on health and they are given option of Health insurance they might be willing to take it. There are opportunities for other insurance products like JOB INSURANCE etc. also. These opportunities can lead to successful businesses but a huge amount of resources need to be invested because it would be needed to change perception of a large section of people. Companies will have to focus on making insurance a normality in Indian life. And these companies will also be creating value for the Indian society in this manner.
On broader sense we can say that with Indian society in transition face there is a need for various products which make Indian life better. Certain western countries are already enjoying these products. This need for products can be converted in to successful businesses provided business is executed effectively. It can lead to big fortunes for many of us.
This transition is taking place in every aspect of life. Our lifestyles are changing. And this changing lifestyle calls for a lot of new products which will suit this change and will create value for us by helping us to adapt with this change. For instance our traditional families had a family security net. But with growing number of nuclear families a whole BIG BUSINESS OPPORTUNITY in terms of various kinds of insurances have opened up.
In some European countries Government provides a huge security net and in US everybody is ensured with various insurances. On the other hand in India there is a huge section of people for which thinks that insurances are wastage of money. They are not aware about possible kinds of insurances and they do not directly realize the need for these insurances. For instance a family may be spending 500 rupees per month on health expenditure without even knowing this. If they are made to realize that they are spending so much money on health and they are given option of Health insurance they might be willing to take it. There are opportunities for other insurance products like JOB INSURANCE etc. also. These opportunities can lead to successful businesses but a huge amount of resources need to be invested because it would be needed to change perception of a large section of people. Companies will have to focus on making insurance a normality in Indian life. And these companies will also be creating value for the Indian society in this manner.
On broader sense we can say that with Indian society in transition face there is a need for various products which make Indian life better. Certain western countries are already enjoying these products. This need for products can be converted in to successful businesses provided business is executed effectively. It can lead to big fortunes for many of us.
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