Basic assessment

Discussion of investment risk is frequently clouded by the word investment being used in two different senses. The first sense is the buying and selling of securities, say gilt-edged Government stock or ordinary shares in the XYZ Company. This sense is referred to as financial investment. The second sense is where a company (nationalized or private) or an individual decides to put some money into, say, building a factory and equipping it with machines and raw materials to make and market some new product or service. This is referred to as project investment. The processes involved, and the way risk is assessed and handled, are very distinct. Project investment is considered in the present chapter; financial investment is discussed in Chapters 7 and 8.

The normal limited liability company quoted on the Stock Exchange has a capital structure designed to handle the risks inherent in the development of new ideas or products. Debenture loans are commonly linked to company ownership of land, buildings and machinery and equipment; ordinary shares, or equity, are linked to the development costs of new products. Bank loans and overdrafts cover working capital, stocks, etc. Debentures and bank overdrafts carry defined rates of interest, while ordinary shares (equities) have a variable rate of dividend dependent on profits. The market value of the shares likewise varies with the current, and anticipated, levels of dividend payments.

A company seeking to acquire substantial fresh capital for risk investment purposes will basically do it in two ways, frequently in combination. First, it will retain a proportion of its profits each year, i.e the dividends paid will not be at the maximum possible level.