Rate of Return &

Economic Environment
Expected Rate of Return
The expected rate of return is the return on investment that an investor
anticipates receiving. It is calculated by estimating the probability of a full
range of returns on an investment, with the probabilities summing to 100%.
For example, an investor is contemplating making a risky $100,000
investment, where there is a 25% chance of receiving no return at all. There is
also a 50% probability of generating a $10,000 return, and a 25% chance that
the investment will create a $50,000 return. Based on this information, the
expected rate of return is:
• $0 return x 25% = $0 return
• $10,000 return x 50% = $5,000
• $50,000 return x 25% = $12,500
Expected Rate of Return
• The investor then sums these projections to arrive at an expected rate of
return of $17,500, or 17.5%, which is calculated as:
• $17,500 sum of returns ÷ $100,000 investment = 17.5% expected rate of return
• Since the probabilities used in these projections are qualitative in nature, it is
quite possible that two people using the same information will come up with
different probability percentages, and therefore different rates of return. This
is especially the case when the individuals use historical information as the
basis for their projections; historical results do not necessarily translate into
future results. When developing a range of possible outcomes for a
prospective investment, one should always examine the risk profile of the
underlying project.
Profitability Index
The profitability index (PI), alternatively referred to as value investment
ratio (VIR) or profit investment ratio (PIR), describes an index that
represents the relationship between the costs and benefits of a
proposed project. It is calculated as the ratio between the present
value of future expected cash flows and the initial amount invested in
the project. A higher PI means that a project will be considered more
attractive.
Profitability Index
• The profitability index (PI) is a measure of a project's or investment's
attractiveness.
• The PI is calculated by dividing the present value of future expected
cash flows by the initial investment amount in the project.
• A PI greater than 1.0 is deemed as a good investment, with higher
values corresponding to more attractive projects.
• Under capital constraints and mutually exclusive projects, only those
with the highest PIs should be undertaken.
PI=PV of future cash flows/ Initial Investment
Financial Analysis
Financial analysis is the process of evaluating businesses, projects,
budgets, and other finance-related transactions to determine their
performance and suitability. Typically, financial analysis is used to
analyze whether an entity is stable or profitable enough to warrant a
monetary investment.
Financial Analysis
• If conducted internally, financial analysis can help managers make
future business decisions or review historical trends for past
successes.
• If conducted externally, financial analysis can help investors choose
the best possible investment opportunities.
Economic Environment

The economic environment can be defined as the combination of all

the economic factors such as, inflation, income, employment rate, etc.
which affect the buying behavior of consumers and thus put an impact
on businesses.
Economic Environment
Microeconomic Environment:
Microeconomic environment factors are those factors which affect
an individual organization and do not affect the whole industry. The
examples of microeconomic factors are demand,
competitors, market size, distribution chain, suppliers, supply, etc.
Macroeconomic Environment:
Macroeconomic environment factors are those which impacts at a
larger level and does not only impacts one company but impact the
whole economy. The examples of macroeconomic factors are inflation,
unemployment, interest rates, taxes, tariff, the trust of customers, etc.
Factors Effecting Economics Environment
1) Demand
Increased demand for product results in more profits whereas a decrease
in demand for your product cause loss. Therefore, companies use
various strategy to increase the demand for their product in the market.
2) Market size
The profit margin of the organization will be low if it has a small market
size. Meaning of market size is the total number of potential buyers in a
market. For example, a company which produces asthma inhalers has a
small market size as it can sell inhaler to people who suffer from asthma.
Factors effecting Economic environment
3) Suppliers
• The production of a company will halt if its suppliers suddenly stop to
provide supplies of raw material to produce a product. Similarly, the
production cost will also increase with the increase in the price of
supplies by the supplier.
4) Supplies
• Similarly, the production process highly dependent on the supplies
supplied by the supplier. The production process will suffer if there is
a scarcity of supplies.
Factors Effecting Economic Environment
5. Income
• Income is the total earning of an individual or an entire family. Income
affects the buying habits of the consumers and thus impacts the
commercial businesses.
• There is a direct relationship between the buying habits of an
individual and his income. For example, people with low income tend
to buy only goods and services which are necessary for living and
don’t spend much money on entertainment and luxurious items
Factors Effecting Economic Environment
6) Inflation rate
• The inflation rate can be defined as the rate at which the process of goods
and services increases. With increased prices, the buying ability of people
gets affected.
• People start buying less, and they spend their money on the necessary
goods and services only. Inflation rate put bad impact on services businesses
• For example, people decrease going out for eating and travel less. Inflation
rate impacts the commercial business, which deals in leisure services and
sells branded goods. Therefore, inflation is undesirable by both consumers
as well as businesses.
Factors Effecting Economic Environment
7) Increasing Interest Rates
• Increasing interest rates also impact the businesses, especially those
businesses where people require to take a loan to buy goods. For
example, people mostly buy houses and cars on loans. Therefore, the
sales of such goods decrease with the increased rate of the interest
rate.
• Because of this reason, many banks advertise their loans services at
lower rates than other banks in order to attract customers, because
people always prefer to get a loan at a lower rate of interest.
Factors Effecting Economic Environment
8. Unemployment Level
• Another factor which impacts the economic environment is the
unemployment level. The countries with high unemployment level
have a weaker economic environment.
• If most of the population will not earn, then they will not have
sufficient money to spend on buying goods and services. This creates
a bad economic cycle in the country.
• For example, if people will not buy, then, companies will not hire
people in order to cut costs, and if companies do not provide
employment, the unemployment level will increase.
Factors Effecting Economic Environment
9) Taxes
• High taxes in the country impacts the economic environment badly.
People will have low disposable income. Taxes not only affect the
consumers, but it also affects businesses as high taxes results in the
high cost of production.
• Therefore, businesses become bound to increase the cost
of products that they sell. As a result of which, people start buying
less, and thus, the economic environment gets impacted.
Factors Effecting Economic Environment
10) Tariffs
• Tariffs are a type of taxes which is imposed on imported goods. Tariffs
put an opposite impact on the sales of goods than taxes. People will
import more goods from foreign countries if there are low tariff rates,
and the local markets will be flooded with cheap foreign products and
will impact the sells of local products.
• Therefore, high tariff rates are preferable, as a result of which there
will be less import of foreign products and people will buy more local
products.
Cont..
• This will not only help the commercial businesses but also the
economy of the country as the money will remain in the country. High
tariff rates also motivate entrepreneurs to set up new businesses and
to sell products which are only available in the foreign market and not
available in the country.
• Therefore, we can say that high tariff rates(for imports) are good for
the economic environment.
Factors Effecting Economic Environment
11) Cost of Labor
• Cost of labor also impacts the economic environment of the business.
High labor cost means the high cost of production and high cost of
production forces businesses to increase the price of the products.
• People will buy a smaller number of goods if the price of the goods is
high and they will look for cheap alternatives for expensive products.
Reduce sales will impact the business negatively.
Factors Effecting Economic Environment
12) Population
•The population has both positive and negative impact on the economic environment.
For example, high population means there are chances of finding skilled employees
•High population results in tough competition and people get ready to even at low
wages which is good for the business as they can hire more people to increase their
production.
•However, high population causes many other issues in the country. for example,
unemployment, poverty, immorality, lower per capita income. The income
and lifestyle of people reduce and thus, there buying capacity, which impacts the
economic environment.
•On the other hand, underpopulation is also not good, as there will be a smaller number
of consumers in the market and lower chances of getting skilled and unskilled
employees. Therefore, it is important to keep a balanced population in the country.
Factors Effecting Economic Environment
13) Innovation
• Innovation has both positive and negative impact of the economic environment.
Innovation pose risk for already established businesses. As entrepreneurs come
with innovative ideas of business and they give competition to the already
established businesses, which impacts the sales of their products.
• However, if companies look ahead and invest in research and development and
can develop innovative ideas to improve their products to fulfill the current
requirement of customers, innovation also helps in to reduce the production cost.
• For example, with the introduction of automation, most of the work of
production, which is performed by labor can now be performed by machines. This
helps in lowering the labor wage expenses.
Factors Effecting Economic Environment
14. International Relations
• The international market condition also impacts the economic environment.
For example, there are many businesses which import and export goods
from international companies.
• The tension between two countries or the increased tariff rates increases
the import cost as a result of which the cost of production also increases.
Increased production cost means increases in the prices of products.
• When prices of products increase, people tend to buy less, and the sales of
the product get impacted. For example, the price of vegetables in Pakistan
increased when the export of vegetables was closed by India Amidst of
tension between both countries.
Factors Effecting Economic Environment
15) Capital Market
• Money and capital market impact the economic environment. When
the capital market is not good, natural, and, human resources can be
used efficiently.
• However, a healthy capital market results in lower dependence on
foreign currency. The nation becomes self-sufficient, and areas like
agriculture, banking, trade, etc. develop.
Factors Effecting Economic Environment
16) Economic Laws
• There are various economic laws such as labor laws, competition
laws, factory act, commercial act; industrial laws impact the economic
environment. Companies are required to set up their business by
being bound by the law, and violation of any law can result in a
penalty or the cancellation of business license.
• In addition to this, the government can introduce a new law which
forces companies to change their method of doing business which
puts a bad impact on the business.
Factors Effecting Economic Environment
17. Social and Cultural Environment
• Social and cultural environment put a great impact on the economic environment of
business. The buying habits and choices of people are highly influenced by the culture
they are born in or the society that they are part of.
• For example, in the southern states of India, women prefer to wear traditional sarees,
whereas western women prefer to buy western clothes. Even the social-cultural
environment impacts the way products are produced.
• For example, A well-known American subsidiary company of PepsiCo, Frito Lays sells
products like lays, Fritos, Doritos, etc., and you find the difference in the flavor of
their products from one country to another.
• In India, they sell spice products, whereas, in America, the flavor of products are less
spice and is according to the taste of people living in that particular region.
Factors Effecting Economic Environment
18) Government Policies
• Government policies also put an impact on the economic
environment. Companies might be required to change the production
process of a product according to the change in government policies.
• For example, companies required to stop the production of certain
drugs after they were banned by the government.
Factors Effecting Economic Environment
19) Technological environment
• Technological environment put a huge impact on the economic
environment. Technology changes rapidly, and organizations are
required to change their technology or update their technology to
keep up with the changing technological environment.
• This requires them to update their machinery and hire new
employees with new skills or to train existing employees to use new
technology. This impacts the production process of the organization
and increases the expenses as a result of which the cost of production
increases and sales of a product decreases.
Factors Effecting Economic Environment
20.Natural Resources
• Natural resources play an important role in the business environment.
• Many business activities are reliable on natural resources. For example,
fuel, water, mineral resources, soil, vegetation, rainfall, topography, etc.
are the basic natural resources which are used frequently in the
production process.
• For example, the vegetation of vegetables and fruits is the main elements
which are used in restaurants. The increase in the price of vegetables and
fruits will reduce the profit margin of restaurants. Similarly, with the
increase in the price of fuel, the cost of transportation will also increase.