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EFFICIENCY ASSESSMENT OF THE FOREIGN TRADE PROJECT BY MEANS OF CAPITAL BUDGETING ELEMENTS AND FINAL PROBABILITIES OF MARKOV PROCESSES
Abstract
To provide qualitatively new growth of economy is possible through increase of labor productivity, increase in competitive investments, growth of the capital. It can be achieved through technological progress, decrease in production costs, stabilization of financial market and reduction of the state participation in business. It demands from the economic subject to adopt weighed decisions on capital budgeting defining efficiency of all foreign trade project. The paper approaches to justify strategic decisions while assessing the alternative investments on projects, which are objects of capital rationing, based on both the NPV, and tools of Markov processes.
Keywords
capital investments, efficiency, foreign trade project, methods of investments assessment, capital budgeting, NPV, administrative decisions, analysis of predicted expenses and benefits, final probabilities, differential equations of Kolmogorov, normalizing condition
AUTHOR Olga Martyanova
PhD, Oryol State University of Economy and Trade, Oryol, 12 Oktyabr'skaya Str., Oryol, 302028, Russia.
E-mail: 1263m@mail.ru
Introduction
At the present stage, both organizations and banks reconstructed their way of work. In the conditions of economic instability, they gave the preferences to big corporate customers. Having established credit payment at the level of 13% per annum, banks compelled organizations to refuse investment projects, as this rate exceeds profitability of many market participants. For example, in 2015 sale profitability of goods, works and services was 9,3%; production of cars and equipment gave - 8,2%; in the construction sphere this indicator was only 5,4%. Thus, banks do not want to work with borrowers, who cannot guarantee repayment of a debt in time.
In spite of the fact that in 2016 domestic banks had available funds, they did not reconsider interest rates for crediting real sector of economy. They directed the funds on deposits in the Central bank of the Russian Federation. The international sanctions, devaluation of ruble, falling of prices on oil strengthened control of banks activity from the regulator of the market that provoked growth of rates on the short-term credits for corporate clients from 9,2% to 20%. The figure 1 reflects it.
Toughening of policy in the banking sector is seen in reduction of the credit organizations number. From 2015 till September, 2016 their number reduced on 171 (Raksha, 2016). Functionality of banks also changes. It influences on universality and geographical arrangement of banks and the largest state banks would prevail at the market. Thus according to the offer of the Central Bank of the Russian Federation submitted for consideration to the Government of the Russian Federation, federal banks would have an exclusive right on operations with currency.
(Central bank of the Russian Federation, 2016)
FIGURE 1. THE AVERAGE INTEREST RATES FOR CREDITS TO A YEAR, PROVIDED BY THE CREDIT ORGANIZATIONS TO THE NON-FINANCIAL ORGANIZATIONS
Statement of a Problem
To make the long-term decisions, including assessment of the planned investments, expenses distributed for some years, benefits from capital investments, is difficult in such conditions, especially, when Russia passed to one-year budget planning instead of three-year planning. Process of decision-making to choose investment projects and determine the sum of capital investments is influenced by factors of uncertainty. Therefore, viability of the foreign trade project depends not only on its profitability, but also on degree of the risk connected with profitability. Minimization of risks forces banks to refuse investment projects with "long money", which return it is difficult to guarantee participate, if only the real estate is pledged.
Such behavior of banks is explainable. The share of the delayed debt exceeded 7% by corporate borrowers and 15% by small business (Raksha, 2016). It explains the replacement of small business risky orders by the large organizations credits. According to data of the banking sector regulator, the portfolio of loans to large business increased by 17% in 2015. The situation with small business differs: crediting was reduced by 5,6% in 2014 and by 28,3% in 2015 (Raksha, 2016). 2016 shows the falling size exceeding the last year's indicator for 4,5%. The export-oriented organizations, the enterprises of
extracting sphere, agro-industrial holdings offering projects over 1 billion rubles to the credit organizations can count on external financing (Raksha, 2016). Banks can give money to organizations, one of which shareholders is the state, or to organizations, offering liquid pledges.
We consider that toughening of the bank policy for clients and actions maintenance of financial sector and flexible exchange rate, carried out by the Central Bank of the Russian Federation and the Government of the country, bear fruits. Confirmation of this conclusion is that fact that the Fitch agency, the only one from the three leading international rating agencies, increased credit rating of the Russian Federation to the investment level with the stable forecast in October 2016 (TASS, 2016). The agency recognizes that Russia overcame influence of external risks such as low oil prices and sanctions of the USA and the EU.
Since 2015, the credit organizations changed approaches to risks assessment that was expressed in development of individual tools to analyze each type of business. The organizations have to perform calculation of perspective estimates to justify possibility of strategic objectives achievement.
Approaches to a Solution
The assessment of investments efficiency at capital budgeting allows to make the decision on the flows volume, which has to be attracted on execution of the foreign trade project. In the modern conditions, the techniques, used to assess financial appeal of investments and allowing to make the decision on capital investment, are necessary to be supplemented with new tools to receive the expected effect. Its existence also allow organization to pass through rigid bank control, analyzing both payments of the borrower, his business plan requirements, and technical justification of investment decisions, contract cost of the project, its mortgage providing.
It is the strategic process, which defines possible projects for the organization of foreign economic activity (here and below - FTA). Methods of strategic models assessment, among which are the NPV, payback, internal standard of profitability, accounting rate of return, are not mutually exclusive. Set of methods that allows to consider some versions of alternative decisions can be used to assess efficiency of investments for FTA organization. The assessment of expenses and benefits with use of financial methods demands revision, as advantages of the project can be defined by factors, expenses and incomes of which are impossible to express in financial terms. For example, strengthening of organization image and advance of a brand, increase of competence level in new technologies, change of market share.
Approaches to FTA assessment, which efficiency lies in the plane of increase in competitiveness of production of domestic producers in the world market, are the subject to revision. Today the Government of Russia undertakes the measures directed on maintenance of organizations exporting non-oil production. The most significant measure is return of the VAT for non-oil production. Institutes of export support are created: the Russian Agency on Insurance of Export Credits and Investments (EKSAR), the Russian Export Center (REC) giving help to exporters in the mode of "a uniform window", the Russian Direct Investment Fund (RDIF), which makes investments in the perspective Russian organizations together with the leading investors of the world.
The special place in development of export takes small business. The special Corporation (MSP) is created for it. The guarantees given by MSP allow businessman to realize the export potential in the presence of accurate indicators of efficiency and terms of conclusion of the competitive production to the international market. However, the competitive goods are made on the import equipment and from the raw materials delivered to Russia under the foreign trade contracts. Therefore, import restriction conducts to reduction of export deliveries. In this connection import substitution demands
policy of "thin settings", the positive effect from which will be shown in three-four years. Strategy of import substitution will be successful, if there would not be an attempt "... to replace import goods from domestic market ..." (Medvedev, 2016). The cornerstone of the successful strategy should be the program directed on improvement of investment climate to support competitive organizations. It would demand existence of qualified personnel and modern equipment, which absence is a limiting factor for long-term foreign trade projects.
Results
Administrative decisions of the FTA organizations need justification of financial consequences of long-term projects. One of methods to assess design offers (including the sphere of foreign trade) is the net present value (NPV). Joint-stock cost would be maximized, if to approve the foreign trade projects with positive NPV. That is possible, if the specified cost of future monetary inflows exceeds the specified cost of outflows. Otherwise, the offer should be rejected. Despite simplicity of the rule, the method has a number of shortcomings. For example:
- being expected, assessment of cash flows can be wrong;
- speed of flows return on initial capital investment is not considered;
- the strategy built on this indicator can cause difficulties for managers not connected with finance;
- lack of a uniform position concerning the indicator that must be uses as a discount
rate.
We consider that other methods to assess efficiency of investments in the foreign trade sphere do not provide maximizing joint-stock cost in spite of the fact that they are widely used. The technique of NPV is based on the theory of "the temporary cost of money", which allows to make the optimum decision including replacement of asset, when the decision has to contain information about what the leaving main means should be replaced by.
In conditions of economic uncertainty, FTA organization can be limited in money, which can be invested in long-term foreign trade projects. Therefore it is necessary to carry out the analysis of its conditions. Not casually, VIII investment forum "Russia calling!" (held by "VTB Capital" on October 12, 2016 in Moscow the Capital") was devoted to money. As money absence faced both commercial organizations and the state that points to a difficult situation in economy. But high-quality growth of economy demands not only creations of additional workplaces, labor productivity increases, but also investments in new technologies and fixed capital which dynamics is given in figure 2.
Investments into fixed capital, billion RUB
'10277.1
lOOOO
■JOCO
8445.2 □ n
6625.0
1
■ n H
! *
Total investments Into fixed capital Own funds Other financing sources Bank credits
(Federal State Statistics Service, 2016)
FIGURE 2. DYNAMICS OF INVESTMENTS INTO FIXED CAPITAL
Organization cannot hope for state support in the form of the measures stimulating their development. Therefore, the decision-making speed and model of their efficiency assessment are those factors, which define a place of organization at the market in the future.
Discussion
The example given below describes procedure of decision-making concerning expediency of purchase or rent of production line by organization exporting the production. Information base of the research is presented in table 1.
TABLE 1. INFORMATION BASE FOR THE ANALYSIS
Indicator Unit of measure Asset X Asset Y
Service life years 7 5
Residual cost EUR 0,00 23 240,00
Purchase conditions:
- price EUR 178 450,00 83 000,00
- payment delay days 0 0
Lease term:
- advance payments EUR per year 29 880,00 14 940,00
- rent term years 7 5
- whether return of asset to the lessor upon termination of rent term is provided no yes
Capital cost % per year 13
For decision-making it is necessary to determine NPV, which calculation is presented in table 2.
TABLE 2. ASSESSMENT OF NPV OF ASSETS COST
Indicator Unit of measure Asset of X Y asset
Discounting factor
- year
5 0,543
1-5 3,517
1-6 3,998
The specified cost on purchase EUR 178 450,00 70 380,68
The specified cost on rent EUR 149 340,24 52 543,98
The carried-out calculations can help to conclude that it is expedient to rent X and Y assets.
The advantage of NPV is essential, as this indicator allows to use various rates during a date of performance of the foreign trade project, because costs of capital attraction, for example, inflation, interest rates, can change in short time. At the same time, problem of the method of the discounted cash flows is t choice of a discount rate answering to conditions of economic subject activity. Low rate can approve all projects to execution, whereas high rate can exempt all investment projects, which can help to strengthen the positions in comparison with competitors. In our opinion, in the conditions of uncertainty the analysis of the sensitivity representing procedure of risk assessment can solve a problem with a choice of a correct discount rate. The procedure changes various factors to define impact of these changes on a size of the studied parameter. The practical realization of procedure is given below.
The organization, the importer of premium class beer, received the offer from the foreign supplier to consider the project on purchase the equipment for a beer taring. Parameters of the project are presented in table 3.
TABLE 3. INFORMATION CARD OF THE PROJECT
Project parameter Unit of measure Sum
Investments EUR 366 019,00
Project term 5,25
Liquidating cost EUR 60 900,00
Output Liters per year 8 750,0
Marginal profit per piece EUR per year 15,75
Constant incremental expenses accounting depreciation EUR per year 26 250,00
Capital cost % 14
The business owner asks to estimate sensitivity of the investment decision to capital cost change. The analysis of the investment decision is provided in table 4.
The calculations showed that if the cost of the capital exceeds 19,2%, the organization would lose interest in the project. The capital cost can increase by 37,1% until it would not be expedient to invest. The NPV can decrease by 48 582,16 EUR, before the indifference point is reached. It means that the annual cash flow can change for 14 151,52 EUR. Generalization of the results allows to conclude that this investment decision for FTA organization is not sensitive to the change of constant expenses, as they can increase by 14151,52 EUR, having reached value of 40 401,52 EUR. The probability of that change of constant expenses would make 53,9% is either small. At the same time, falling of marginal profit for 14 151,52 EUR to 123 660,98 EUR will lead to its change by 10,3% that is caused by deviations in price, volume and efficiency of expenses.
TABLE 4. THE ASSESSMENT OF THE NET SPECIFIED PROJECT VALUE
Period Operation Unit of measure Cash flow Discounting factor The specified cost Discounting factor The specified cost
% 14 20
0 Investment EUR (366019,00 ) 1 (366019,00 ) 1 (366019,0 0)
1-5,25 Money inflow per year EUR 111562,50 3,433 382994,06 2,991 333683,44
5,25 Residual cost EUR 60900,00 0,519 31607,10 0,402 24481,80
NPV (NPV) EUR 48582,16 (7853,76)
Internal standard of profitability % 19,2
In conditions of uncertainty, it is difficult to predict the result of future investment decision. Therefore the 10,3% mistake is expected. The marginal profit is defined by the size of variable expenses and sale price. Without possessing the detailed information, it is impossible to carry out the further project assessment. The analysis of sensitivity is made without probability of commission of events. From business owner position, the most perspective result should be subjected to more detailed study for making a final decision. We consider that the advantage of the method is focusing of a decision-maker (further -DM) on the factors having the maximum impact on efficiency of the project including the foreign trade sphere. Possessing such information, business owner or DM can initiate
actions, which projects' parameters would not be beyond the control indicators determined by the economic subject.
If the results received from the sensitivity analysis do not strengthen DM's decision to realize this project, it is necessary to carry out a complex risk assessment on the basis of distribution of probability on the most essential factors. It would help to estimate NPV. In our opinion, the interpretation of the results is important as it analyzes each factor separately. Whereas in conditions of uncertainty, some factors can have simultaneous impact on the project that would define the result. Probabilities of an optimum outcome for each factor are given in table 5. The analysis of probable outcomes values allows DM to express high confidence in realization volume assessment, whereas there is smaller degree of confidence concerning other factors. Having assumed that each factor accepts the value irrespective of other factor, probability of the event with simultaneous values of three factors is defined as follows:
0,8 x 0,6 x 0,5 = 0,24.
The received result allows to note that there is 24% probability that the most probable NPV would turn out.
TABLE 5. INFORMATION BASE ON PROBABLE FACTORS OUTCOMES
Factor Probable outcome
Sales volume in value terms 0,8
Equipment cost 0,6
Term of implementation of the foreign trade project 0,5
Thus, in conditions of uncertainty, it is impossible to make decisions on projects, being based only on values of coefficients, as they do not consider the attitude towards risk. Besides calculation of NPV, DM has to take into account the amount of dispersion, distribution of results probability for various scenarios.
To estimate efficiency of economic activity, the subject has to be able to estimate business environment condition on both short-term and medium-term prospect. The sphere of foreign trade is not an exception. To solve the task, the organization is expedient to carry out probable modeling. There is a practical realization of forecast for medium-term prospect and making decision about the contract with the foreign supplier (to purchase the equipment for beer taring) depending on condition of domestic market, which can be in one of three states excluding each other:
si- the market of balance corresponding to a state, when demand for premium class beer is identical to its offer;
s2- the market of the consumer, which is characterized by excess of offers over demand;
s2 - the market of the importer, which is equivalent to deficiency of beer, therefore demand surpasses beers offer.
Information received after the analysis of domestic market (S system) for the previous periods shows that its state in the future is mainly defined by the present condition. Transition of domestic market from one state to another in any casual time point is characterized by density of probabilities, which changes are the smallest and set by the following matrix:
(0 3 M
5 = (2,5 0 1,5) (1)
\0,5 3,5 0 J
Being guided by the input data, system S has a discrete uniform Markov process with continuous time. The streams of events causing transition of the studied S system from one state to another are elementary streams (Martyanova, 2016). The marked state graph is presented on figure 3.
The graph analysis shows that the S system can pass from any state into any other state for final number of steps, i.e. it is ergodic. The work (Labsker, 2014) proved that if number of S system conditions is finite, the S system is ergodic and all streams of events causing transition of S system from one state to another are elementary streams, then there are final probabilities of states (pi), defined as
pi = lim pi(t), i = 1, ...,n
(2)
where pi(t) - probability of si conditions of S system in t timepoint.
FIGURE 3. STATE GRAPH OF DOMESTIC MARKET
To find final probabilities, it is expedient to use the system of Kolmogorov differential equations (Labsker, 2014).
dpi(t) dt
= -(Z]n=1Aij)pi(t) + Z]n=iAijpj(t), i=1.....n; t > 0. (3)
If to pass to a limit at t ^ + to in (3), it transforms to the system of the uniform algebraic linear equations concerning n unknown pi, i = 1,..., n(Labsker, 2014)
-(I?=iAiy)Pi + I?=iAiyPy = 0, i = 1.....n (4)
The probability of continuous random pi(t) variable at t ^ + to seeks to pi constant, and the constant derivative is zero.
Based on the above, we have a system of linear equations.
4pi + 2,5p2 + 0,5p3 = 0;
3pi - 4p2 + 3,5p3 = 0; (5)
Pi + 1,5p2 - 4p3 = 0.
After transformations we have the following:
f-4p1 + 2,5p2 + 0,5p3 = 0; P2 = 1,824p3; Pi = 4p3 - 1,5p2;
After transformations we have the following:
r-4p1 + 2,5p2 + 0,5p3 = 0;
P2 = 1,824P3; Pi = 1,264p3.
Therefore, the common solution of (5) system depending on one p3 e [0,1] parameter is the vector
(Pi = 1,264p3; P2 = 1,824p3; P3).
Having replaced the first equation with normalizing condition, we have the system allowing to find the decision, which meets the demanded conditions:
Pi + P2 + P3 = 1; P2 = 1,824p3; ,pi = 1,264p3.
It means the following:
rpi = 0,310;
Jp2 = 0,447;
(p3 = 0,245.
Thus, the forecast for the organization on condition of domestic market for medium-term prospect is as follows: after sufficient time (p2 > p1,p3) it is most likely that the offer of premium class beer would exceed demand, i.e. it is overproduction crisis. Therefore it is not favorable to organization to sign the contract for production equipment, thus being exposed to a maximum risk level.
Conclusion. We consider that in the conditions of economic uncertainty when participants of the foreign trade relations place emphasis on structural financing, the method of assessment of capital investments by means of NPV allows to make optimum decision, if the purpose is maximizing joint-stock cost.
As investment process represents a cycle, not a separate event, the financial assessment of the foreign trade projects is only part of investment process, which needs the post-design analysis, allowing to define correctness of originally made decision. Therefore, it represents a perspective assessment, which has to be carried out within the system of project monitoring in the sphere of foreign trade.
The assessment of the complete foreign trade project needs to be carried out not only to reveal expenses and define the gained income, but also to make conclusions that helps decision-making in conditions of uncertainty, stimulating management of the organization to responsible behavior. One of such decisions can be factoring or leasing that allow to increase efficiency of the activity in the world market. Use of these tools is the extremely actual for FTA participants, having problems with working capital as for the last two years banks are extremely undesirable to credit the distributors signing contracts with foreign producers on the terms of advance payment. Such policy of banks is explained by instability of the market and high risks of credit non-return.
In spite of the fact that banks, according to forecasts of the Central Bank of the Russian Federation, would soften credit conditions in 2017-2018. The leasing and factoring market of industrial equipment would grow by 30 - 40% by the end of 2016 (Raksha, 2016). We consider that the additional impulse to demand in this segment would be given by the
"National leasing company" created by the State corporation "Rostechnologii" in August 2016.
Thus, foreign trade market participants optimize the activity, increase efficiency of investment and profitability of business that is caused by aspiration of organizations not to allow bankruptcy in the current economic situation. The decision on capital investment demands efficiency assessment of alternative design offers with use of various methods of investment analysis considering both financial, and non-financial factors.
Post-design assessment, without being a control method, acts as the instrument of management for improvement planning in the future, as this type of assessment possesses a number of advantages, which belong to both future investment decisions, and the system of investment estimates. What, finally, increases efficiency capital investments in the sphere of foreign trade.
Recommendations
Generalizing the results, it is possible to conclude:
1. The assessment of capital investments in the foreign trade projects on the basis of NPV allows to receive potentially right decision about investments accounting that the purpose is maximizing joint-stock cost. This indicator helps DM in case of a lack of funds for implementation of investment decisions.
2. The analysis of sensitivity of capital investments to essential factors changes including influencing parameters of cash flows is necessary to carry out at project risk assessment.
3. Advantage of post-project assessment is its influence on both future investment decisions, and system of their estimates, because the decision on refusal of capital investments is made on the basis of the relevant future expenses and profits formed at implementation of the foreign trade project.
4. In practice, the person, responsible for decision-making, can use other tools to justify financial consequences of long-term projects implementation. The special place here is taken by the Markov processes allowing to receive estimates of perspective character, based on the current position of organization.
5. In the analysis of capital, Markov processes allow to consider investments risks and compare the alternative projects, which are objects of capital rationing.
REFERENCES
Labsker, L.G. (2014). Probabilistic modeling in financial and economic area: studies. grant (2nd prod.). Moscow, INFRA-M.
Martyanova, O.B. (2016). Modeling of efficiency of import operations on the basis of Wald-Sevidzha criterion and final probabilities of Markov process. European Social Science Journal, 2 (74-87).
Medvedev, D. A. (2016). Social and economic development of Russia: finding of new dynamics. Economy questions, 10 (5-30).
Raksha, A. (2016). With the credit it is better to wait till 2017. Finance director, 10(164) (16-19).
Federal State Statistics Service. (2016). Russia in figures. 2016. http://www.gks.ru/bgd/regl/b16_11/IssWWW.exe/Stg/d02/25-05.doc
Central bank Russian Federation, 2016. Interest rates and structure of the credits and deposits for urgency. October, 2016, https://www.cbr.ru/statistics/?PrtId=int_rat
Fith improved the forecast for a credit rating of the Russian Federation to "stable". (2016, October 14). TASS, news agency of Russia. October 22, 2016,http://tass .ru/ekonomika/3706634
