Sample Accounting Research Paper on Capital Investments in Emerging Markets

Capital Investments in Emerging Markets

Recent statistics indicate that emerging markets represent a huge share of capital investments in the global equity market. The rapid growth of capital investments in the emerging markets, such as China, India, Latin America, and Africa has resulted in many countries across the globe redefining their strategies, by adopting new methods that are likely to improve their investment return. The Coca Cola Company is one such company that has introduced significant changes in its capital investment plans in the emerging market. This paper investigates and reviews current plans that the Coca Cola Company has identified for capital investment in the emerging market.

The Coca Cola Company is a leading American multinational company that specializes in the production and sales of soft drink products, as well as mineral water. The company has global presence in major developed market, such as in Europe and North America. However, its presence is limited in emerging market. Nonetheless, over the past few years, the Coca Cola Company has come up with some strategic plans of increasing its capital investments in the market markets – it primarily targets China, India, and Africa. These markets have attracted many multinational companies because of the favorable conditions, such as ready demands, and reduced risks among others. By the end of 2015, the Coca Cola Company significantly increased its capital portfolio in emerging market from 10% to 15%, and this percentage is expected to be increased in the coming years.

In the year 2015, the Coca Cola Company identified major plans for increasing its capital investments in the emerging market, its plans targeting specifically India, China and African countries. The Coca Cola Company has been using traditional methods for evaluating their capital investments in the developed markets. However, due to the uniqueness of emerging markets, these traditional methodologies need to be supplemented if the company has to achieve optimal growth and benefit. There are three major traditional methods for evaluating capital investment namely the Net Present Value, the Internal Rate of Return, and lastly the Payback Period. Under the Net Present Value (NPV) method, capital investment is evaluated based on the net future cash flows after deduction of total taxes.  In this case, the capital investment is considered worthy if the net present value exceeds zero. On the other hand, the internal Rate of Return method considers the discount rate at the present value that equals the capital investment outlay. The capital investment evaluation method is widely used by analysts. The latter method, Payback Period, is calculated as the number of years that is needed to fully recover the initial capital investment in the business. Even though it is very simple, the Payback Period method has numerous flows makes it unsuitable for evaluation of capital investments (Götze, Northcott & Schuster, 2015).

These traditional methods of evaluating capital investment have various drawbacks – these drawbacks can be controlled in order to reduce the overall risk by supplementing the traditional methods with other techniques. The best methodology that the Coca Cola Company can use supplement these traditional methods in order to reduce risks in the market is to include the elements of profitability in the evaluation method. This can be done effectively by calculating the probability index for each capital investment. Capital investments depend on several variables, which must be considered, primarily, the business’ need to yield potential capital. The use of probability index is essential in reducing the risk appetite because it leads to the development of new products that yield capital in the market.

The primary rationale of probability index methodology is that it considers all the present cash flows that are expected to be yielded from the project. Another rationale of using probability index methodology is that it considers the initial investments that would be required within the project’s lifetime thus making it more accurate and reliable in evaluating the capital investment. This methodology is beneficial because it gives the ratio of present values of all future outflows and inflows of cash to the project, which makes it a reliable measure of capital investment decision for any time of project.

There are several advantages of using the probability index in evaluation of the capital investment in any type of project. For instance, it is very simple to calculate as compared to the traditional methods of capital evaluation. Another advantage of using this methodology is that it recognizes and appreciates the time value of money, which is very essential in expressing the true expectation of initial outlay. The last rationale for using probability index calculation is that it gives better criteria for selection of project when different capital investments are involved. For these reasons, the probability index methodology is appropriate for supplementing the traditional methods of evaluating capital investment thus should be adopted by the Coca Cola Company.

Inflation is a very significant factor that affects capital investments in both emerging and developed market. It is an important factor of consideration in the emerging market because of the market instability and presence of several influencing factors. Inflation could potentially affect the Coca Cola’s planned capital investments in emerging market in several different ways. In most cases, problems associated with insufficient monetary restraint and a mix of strong economic growth often crop up in emerging markets such as India, china and some African countries. Due to these factors, most emerging market are often affected by runaway inflation which eventually leads to devaluation of currencies, reduction of corporate profit margin as well as overall slow economic growth, which directly affect the planned capital investment. For instance, inflation rate in India and most African countries have been fluctuating every year and hitting the highest point in the subsequent years (Bierman & Smidt, 2012).

One possible way through which inflation will affect planned capital investment in emerging market is the increment in transactional and informational costs, which eventually might prevent the Coca Cola Company from increased capital investment in emerging markets. For instance, when inflation is high, it makes the nominal values for capital uncertain; thus, the company would find it difficult to plan its capital investments in the market. As a result, the company may become reluctant to capital investment in the market because it cannot corrected predict the market prices. Due to this reluctance, inflation would certainly inhibit or reduce the rate of capital investment in emerging markets and ultimate financial recession as companies resort to being more cautious.

The Coca Cola Company can use several methods of evaluating capital investments. The most commonly used methods are Internal Rate of Return, Payback Period as well as Net Present Value. These methods have their advantages and disadvantages and might not provide most accurate result. Despite its few weaknesses, the most accurate method that the Coca Cola Company can use to evaluate its capital investments in emerging market is Modified Internal Rate of Return. The development of this method gives it ability to resolve most problems experienced by the Internal Rate of Return technique. First, it does not assume that positive cash inflows are reinvested in the business at the same rate. Under the modified internal rate of return, all cash flows are subjected to terminal value calculated using specified discount rate applicable to it. There are three major advantages of this method; it includes time value of money, it includes all cash flows in the entire project lifetime, and lastly it uses a single rate thus avoiding confusion. The knowledge of this method would impact the management decisions positively. This is because the management team at Coca Cola Company will resort to this method, which is more accurate and effective in evaluation of capital investment.

The management would make few modifications when evaluating projects in North America as compared to the global market. The modifications would be influenced by the nature of the two markets. In North America, it is essential to stick specific issues related to the market while in the global perspective the management would use generalized information. One key consideration in North America would be the level of market saturation. As we all known, North America is certainly saturated with soft drink products and market expansion criteria would not be highly recommended when considering capital investment. On the global market, it is essential to consider market expansion criteria when deciding on capital investment because some areas have not been reached. This information will impact the decision made by the coca cola company by coming up with new criteria for expanding into the global market through new market entry.

There are several benefits of using sensitivity analysis in the evaluation of projects for capital investment the first benefit being the ability of determining how different values will independent impact particular dependent variables under consideration. The second benefit is that sensitivity analysis is the ability to direct the management’s efforts. By identifying crucial areas, it provides a level of centration that enables the management to direct discharge their duties. This approach will provide a competitive advantage for the Coca Cola Company by enabling ease of automation and also acting as a source of information for planning (Bos, Sanders & Secchi, 2013).

References

Bierman Jr, H., & Smidt, S. (2012). The capital budgeting decision: economic analysis of investment projects. Routledge.

Bos, H. C., Sanders, M., & Secchi, C. (2013). Private foreign investment in developing countries: a quantitative study on the evaluation of the macro-economic effects (Vol. 7). Springer Science & Business Media.

Götze, U., Northcott, D., & Schuster, P. (2015). Capital Budgeting and Investment Decisions. In Investment Appraisal (pp. 3-26). Springer Berlin Heidelberg.