Investment Strategy Of Northwest Capital Management

Description of Northwest Capital Management Hedge Fund

Question:

Discuss about the Uncoupling Direct and Indirect Plant.

In this case study, Troy Dexter is the founder and has established hedge fund for the purpose of investing activities. Northwest Capital Management is the name of hedge fund that has been established by Troy Dexter. Main activity or purpose of hedge fund is to invest funds in different or diversified securities. Investment in different types of financial assets to earn maximum profit is the objective of hedge fund established by Troy Dexter (i.e. Northwest Capital Management). Aim of hedge fund is to earn profit from long term investments or macro investment strategy has been adopted by Troy Dexter. In the concept of hedge funds, Troy Dexter is making investment for personal purpose and there are few members whose funds are invested in the overall fund (Aslan & Kumar, 2016). For the purpose of investment decisions, Troy Dexter predicts that Australian housing marketing that is presently doing well or having boom in it will slow down. Strong growth seen in housing sector will comes to a send in near future.  On the other hand, Troy Dexter believes that oil prices will increase or escalate. Therefore more investments are required to be made in oil or energy industry. For this purpose, Troy Dexter is currently buying treasury bonds in debt market and energy stock in share market.

Direct securities are those securities which are issues and allotted in the name of applicant only. Direct securities can be defined as the direct investment made by investor in any form of market and are available for sell or purchase. Direct form of securities is transacted in the name of owner (Campbell , 2009). In case of direct securities, investors who are willing to purchase securities in want of some return or financial consideration in the form of return on investment will participate in the transaction. Direct securities are traded in financial market or are connected with financial market. In case of direct market or securities, Borrower Company issues shares or other instruments in the financial market and then those shares or instruments were bought by investors. There are two types of securities i.e. direct securities and indirect securities. Direct securities are those securities which are large in term of denomination but are traded in small no of quantities or in small volume (Cavusoglu et al., 2015). Maturity period of direct securities are usually longer i.e. these are traded in longer period as compared to indirect securities. On the other hand, indirect securities can be defined as the securities which are issued by banks or secondary organizations or fund management companies are secondary securities for investors. It can be analyzed that, indirect securities has indirect impact and gain or loss transfer system with the fund management companies or other financial intermediaries (Oba, 2014). It shall be noted that indirect securities are not allotted directly to the investors but investors are required to apply for the securities. Secondary securities are smaller in denomination and are traded in huge volume or trading at large level. Maturity level of indirect securities is always shorter i.e. indirect securities traded in quick sessions. From the point of view of Northwest Capital Management, are treasury bonds and energy stocks are direct or indirect securities? Explain.

Troy Dexter's Investment Objectives

In present case, Northwest Capital Management is the investment company that has accepted investments from individual investors. They also tends to invest from in house funds also in various investment options like shares, bonds, securities, etc. current they had invested in treasury bonds in the debt markets and energy stocks in the share market. These are those investments which involves in-house funds and of individual investor’s also (Olmo & Sanso, 2012). Since Northwest Capital Management has invested directly in the debt market and equity market therefore these are direct securities for Northwest Capital Management. When any financial intermediaries invest funds in any sector or in investment opportunity, then this becomes direct investment or direct securities for financial intermediaries. On the other hand, these investments made by financial intermediaries become indirect securities or indirect investments for individual investors.

In this case, there can be two prospective i.e. one from Northwest Capital Management prospective and one from individual investors’ prospective. Both prospective is different from each other in terms of securities i.e. direct and indirect securities. From the prospective of investor, investment made in different areas are indirect securities as they does not hold any direct link or contact with the investments made (Gounopoulos, Staikouras & Zhao, 2013). On the other hand, in terms of Northwest Capital Management i.e. hedging investment fund has created direct securities as all risk and rewards related to investment will be first received by Northwest Capital Management and then it will be spread over individuals investors according to size of their investment. Therefore in this case, from the point of view of Northwest Capital Management, are treasury bonds and energy stocks are direct securities.

Indirect transfer of securities using financial intermediaries i.e. other than banks has some procedure to be followed. When any investor, invests any amount sin any securities through or with the help of financial intermediaries then that process is leading towards indirect security creation. Distinct from direct securities or direct channel of investment, there are some channels or financial intermediaries or financial institution (except from banks) which are formed or registered to provide services to prospective investors in terms of investment. These financial intermediaries include co-operative societies, insurance companies, investment companies, investment funds, etc created to mobilize funds of individual investors in to financial market as collective investment (Stenberg & Bjorkman, 2010). This type of financial intermediaries collects funds from individual investors, create pool of funds and then invest these funds into diversified sectors and in different securities. Logic or objective behind creation of these funds or companies is to achieve profit from diversified investment strategy for large no of investors. Since single investor, cannot create pool of funds to invest in different sectors, in order to hedge losses of one investment from other investment.

In present case of Northwest Capital Management, Northwest Capital Management is the fund management or investment company engaged in collecting or seeking funds from individual investors for the purpose of investing in different securities or investment opportunities. Services is provided by Northwest Capital Management to its investors in terms of investment is the direct holding of securities (Strachman, 2012). As investors has invested directly in the Northwest Capital Management and nothing to do with financial market and investment decisions. All the decisions of investment will be taken by the Northwest Capital Management and but risk and rewards as specified in the contract between inventor and Northwest Capital Management will be transferred.

Direct Securities vs. Indirect Securities

It shall be noted here that there is creation of direct securities between investor and Northwest Capital Management. But there are direct securities between investors and actual investment sectors or options. Northwest Capital Management has acted intermediaries between investments made and funds investors by investors. At the time of investment, investors in Northwest Capital Management or in the pool created by Northwest Capital Management for the investment, Northwest Capital Management has issued receipt of amount invested. Therefore particular investor has direct securities created from the prospective of investors.

Year	Cash flows	Cumulative	Cash flows	Cumulative	PV Factor	PV of Lathe A	PV of Lathe B
0	$ (660,000)	$ (660,000)	$ (360,000)	$ (360,000)	1	$ (660,000)	$ (360,000)
1	$ 128,000	$ (532,000)	$ 88,000	$ (272,000)	0.885	$ 113,280	$ 77,880
2	$ 182,000	$  (350,000)	$ 120,000	$  (152,000)	0.783	$ 142,506	$ 93,960
3	$ 166,000	$ (184,000)	$ 96,000	$ (56,000)	0.694	$ 115,204	$ 66,624
4	$ 168,000	$ (16,000)	$ 86,000	$ 30,000	0.613	$ 102,984	$ 52,718
5	$ 450,000	$ 434,000	$ 207,000	$ 237,000	0.543	$ 244,350	$ 112,401
					NPV	$ 58,324	$ 43,583

Payback period

Lathe A = 4 years + ($ 16,000 / $ 450,000) = 4.35 years

Lathe B = 3 years + ($ 56,000 / $ 86,000) = 3.65 years

Analysis: Payback period can be defined as the period, which is used for the purpose of calculating period of time. This calculated period denotes, recovery period of cash outflows in the form of cash inflows of the capital project. Lower payback period denotes efficiency in capital project as compared to higher payback period (Sirinanda et al., 2015). Payback period is the measure of liquidity of the project i.e. how quickie capital project can generate funds and recover initial investment for management of the business organization. In case of Norwich Tool, they had undertaken two capital projects lathe A and lathe B and management required payback period to be 4 years or less (Wang et al., 2015). On the basis of management requirement of desired payback period, capital project of lathe B shall be selected since it has lower payback period as compared to lathe A. Lathe B’s payback period also covers management requirement of 4 years or less payback period.

Assuming equal risk, use the following sophisticated capital budgeting technique to assess the acceptability and relative ranking of each lathe.

(1) Net present value (NPV)

Lathe A = $ 718,324 – $ 660,000 = $ 58,324

Lathe B = $ 403,583 - $ 360,000 = $ 43,583

Net present value method is one of the most commonly used and most effective capital budgeting method. Net present value method is used to calculate profitability in the capital project. NPV method uses the concept of time value of money i.e. adjustment to inflation rate or cost of capital is done in this method. This rate is known as discount rate or hurdle rate or cost of capital of project. Project having higher NPV shall be selected as that project will be more profitable as compared to other project under consideration (Leyman & Vanhoucke, 2017). In case of Norwich Tool, lathe A is generating $ 58,324 NPV and lathe b generating $ 43,583 NPV. Therefore in such basis, capital project of lathe A shall be selected.

Years	Lathe A	Lathe B	PV Factor @ 20 %	PV of Lathe A	PV of Lathe B
0	$ (660,000)	$ 360,000	1.000	$ (660,000)	$ (360,000)
1	$ 128,000	$ 88,000	0.833	$ 106,624	$ 73,304
2	$ 182,000	$ 120,000	0.694	$ 126,308	$ 83,280
3	$ 166,000	$ 96,000	0.579	$ 96,114	$ 55,584
4	$ 168,000	$ 86,000	0.482	$ 80,976	$ 41,452
5	$ 450,000	$ 207,000	0.402	$ 180,900	$ 83,214
				$ (69,078)	$ (23,166)

Indicate which lathe you would recommend, if either, if the firm has

(1) Unlimited funds or

When business organization has unlimited funds or financial resources with them, then in this situation, capital projects having higher NPV i.e. profitability shall be selected for investment.

(2) Capital rationing

Capital rationing in the situation which denotes limitation of financial resources or availability of funds with business organization. In this situation, ranks to capital projects will be provided to capital projects on the basis of NPV, IRR and profitability index (Shu, Zeithammer, & Payne, 2016). Project having higher profitability index shall be selected for the investment (Bano et al, 2011). Following is the profitability index of both the projects:

Profitability index = Present value of cash inflows / Present value of cash outflows

Lathe A = $ 718,324 / $ 660,000 = 1.09

Lathe B = $ 403,583 / $ 360,000 = 1.12

Therefore on the basis of profitability index, lathe B capital project shall be accepted.

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