Investing in small companies
Investing in small companies like AMS may be very rewarding, but it can be very risky in case an investment fails to pay off. This is because many startups do not always succeed. As a result, the risk of losing the whole investment is a real possibility. When an investment is riskier, a discount rate is regulated to at least have a reasonable value. Higher discount rates lead to a lower value for riskier investments, hence selecting a reasonable discount rate is key.
Ai Mei Shen is a startup privately held corporate thus it is smaller in size hence riskier high discount rates and operations. Due to the reason that AMS is a new company, the business seems to be exposed to certain risks regarding concentration, liquidity, and access to capita among many other risks.
Table 1 shows Venture Capital Investors’ rates of return. The rates of return represent the net gain or loss of an investment over a given time expressed as a percentage of the initial cost of investment. Referring to the Venture Capital Investors rates provided in the table, the implied discount rate in part one is 12.5% which is lower than the Rates of Return in the Venture Capital Investors rates shown in the table. As the discount rate is much lower, the return of the investment would be valuable since low discount rates lead to a higher return on investment.
The discount rate may be influenced by various factors including social and economic factors. The factors affecting discount rates are as follows. In economic factors, economic risks have a potential impact on the discount rate (Park & Matunhire, 2011). This factor is subdivided into three including price risk, exchange risk as well as the demand risk. Regarding the price risk, the price risks involve possible variability of future prices. In the exchange risk, this risk results from the foreign exchange which involves the international operation in the world where there is variation in relative currency (Park & Matunhire, 2011). The exchange rates have a significant influence on revenue especially if an organization operates in a country where there are different currencies. In the demand and supply, the dynamic economic environment has led to the difficulty in attaining the demand forecast. General economic conditions may directly affect the discount rates.
Regarding social factors, discount rates may also be affected by cultural norms. For example, certain communities may forbid certain discount rates (Park & Matunhire, 2011). As a result, there might be difficulty in investing in such communities. Besides, market expenses may also impact the discount rates (Rojo-Ramirez, Alonso Canadas & Cruz-Rambaud, 2011). An individual’s experience in a given market may influence the discount rate (Park & Matunhire, 2011). People with more money to spend as well as more sophisticated investment knowledge have more access to capital compared to individuals from different socio-economic backgrounds hence the influence may cascade to discount rate (Park & Matunhire, 2011). Herd behavior may also influence the discount rate. This is in the sense that investors always follow leads of large groups irrespective of how valuable a decision may be hence influencing the rates of return.