Project_Valuation.ppsx

VALUTAZIONE DI PROGETTI
NOZIONI DI VALORE I
matteo.marcantognini@gmail.com

Take Microsoft as an example
Anno terminato il 30 giugno 2021 2022 2023 30-giu 2022 2023 Variazioni Anno terminato il 30 giugno 2021 2022 2023 Anno terminato il 30 giugno 2021 2022 2023
Reddito: Impieghi Operazioni Azioni ordinarie e capitale versato
Prodotto 71.074 72.732 64.699 Attività correnti: Reddito netto 61.271 72.738 72.361 Saldo, inizio periodo 80.552 83.111 86.939
Servizio e altro 97.014 125.538 147.216 Contanti e mezzi equivalenti 13.931 34.704 20.773 Rettifiche per riconciliare l'utile netto con la liquidità netta derivante dalle operazioni: Azioni ordinarie emesse 1.963 1.841 1.866
Entrate totali 168.088 198.270 211.915 Investimenti a breve termine 90.826 76.558 -14.268 Ammortamenti e altro 11.686 14.460 13.861 Riacquisto di azioni ordinarie -5.539 -5.688 -4.696
Costo del ricavo: Crediti, al netto del fondo svalutazione crediti 44.261 48.688 4.427 Spese per compensi in azioni 6.118 7.502 9.611 Spese per compensi in azioni 6.118 7.502 9.611
Prodotto 18.219 19.064 17.804 Inventari 3.742 2.500 -1.242 Perdite (utili) nette riconosciute su investimenti e derivati -1.249 -409 196 Altro, netto 17 173 -2
Servizio e altro 34.013 43.586 48.059 Altre attività correnti 16.924 21.807 4.883 Imposte sul reddito differite -150 -5.702 -6.059 Saldo, fine periodo 83.111 86.939 93.718
Costo totale dei ricavi 52.232 62.650 65.863 Totale attivo corrente 169.684 184.257 14.573 Variazioni delle attività e passività operative: Utili trattenuti
Margine lordo 115.856 135.620 146.052 Attività immobilizzate Crediti -6.481 -6.834 -4.087 Saldo, inizio periodo 34.566 57.055 84.281
Ricerca e sviluppo 20.716 24.512 27.195 Immobili e macchinari, al netto del fondo ammortamento 74.398 95.641 21.243 Inventari -737 -1.123 1.242 Reddito netto 61.271 72.738 72.361
Vendite e marketing 20.117 21.825 22.759 Beni in diritto d'uso in leasing operativo 13.148 14.346 1.198 Altre attività correnti -932 -709 -1.991 Dividendi in contanti delle azioni ordinarie -16.871 -18.552 -20.226
Generale e amministrativo 5.107 5.900 7.575 Investimenti azionari 6.891 9.879 2.988 Altre attività a lungo termine -3.459 -2.805 -2.833 Riacquisto di azioni ordinarie -21.879 -26.960 -17.568
Reddito operativo 69.916 83.383 88.523 Avviamento 67.524 67.886 362 Debiti commerciali 2.798 2.943 -2.721 Effetto cumulativo delle modifiche contabili -32 0 0
Altri ricavi, netti 1.186 333 788 Attività immateriali, nette 11.298 9.366 -1.932 Entrate non guadagnate 4.633 5.109 5.535 Saldo, fine periodo 57.055 84.281 118.848
Reddito prima delle imposte sul reddito 71.102 83.716 89.311 Altre attività a lungo termine 21.897 30.601 8.704 Tasse sul reddito -2.309 696 -358 Altri utili (perdite) complessivi accumulati
Accantonamento per imposte sul reddito 9.831 10.978 16.950 Totale attivo immobilizzato 195.156 227.719 32.563 Altre passività correnti 4.149 2.344 2.272 Saldo, inizio periodo 3.186 1.822 -4.678
Reddito netto 61.271 72.738 72.361 Totale attivo 364.840 411.976 47.136 Altre passività a lungo termine 1.402 825 553 Altra perdita complessiva -1.374 -6.500 -1.665
Utile per azione: Passività e patrimonio netto Liquidità netta da operazioni (1) 76.740 89.035 87.582 Effetto cumulativo delle modifiche contabili 10 0 0
Di base 8,12 9,7 9,72 Passività correnti: Finanziamento Saldo, fine periodo 1.822 -4.678 -6.343
Diluito 8,05 9,65 9,68 Debiti commerciali 19.000 18.095 -905 Premio in contanti sullo scambio di debiti -1.754 0 0 Patrimonio netto totale 141.988 166.542 206.223
Media ponderata delle azioni in circolazione: Parte corrente del debito a lungo termine 2.749 5.247 2.498 Rimborsi del debito -3.750 -9.023 -2.750 Dividendi in contanti dichiarati per azione ordinaria 2,24 2,48 2,72
Di base 7.547 7.496 7.446 Compensazione maturata 10.661 11.009 348 Azioni ordinarie emesse 1.693 1.841 1.866
Diluito 7.608 7.540 7.472 Imposte sul reddito a breve termine 4.067 4.152 85 Riacquisto di azioni ordinarie -27.385 -32.696 -22.245
Entrate non acquisite a breve termine 45.538 50.901 5.363 Dividendi in contanti delle azioni ordinarie pagati -16.521 -18.135 -19.800
Altre passività correnti 13.067 14.745 1.678 Altro, netto -769 -863 -1.006
Totale passività correnti 95.082 104.149 9.067 Liquidità netta utilizzata nei finanziamenti (2) -48.486 -58.876 -43.935
Passività a lungo termine Investimento
Debito a lungo termine 47.032 41.990 -5.042 Ampliamento di beni e attrezzature -20.622 -23.886 -28.107
Imposte sul reddito a lungo termine 26.069 25.560 -509 Acquisizioni di aziende, al netto della liquidità acquisita, e acquisti di attività immateriali e altre attività -8.909 -22.038 -1.670
Entrate non acquisite a lungo termine 2.870 2.912 42 Acquisti di investimenti -62.924 -26.456 -37.651
Imposte sul reddito differite 230 433 203 Scadenze degli investimenti 51.792 16.451 33.510
Passività per leasing operativo 11.489 12.728 1.239 Vendite di investimenti 14.008 28.443 14.354
Altre passività a lungo termine 15.526 17.981 2.455 Altro, netto -922 -2.825 -3.116
Totale passività a lungo termine 103.216 101.604 -1.612 Liquidità netta utilizzata negli investimenti (3) -27.577 -30.311 -22.680
Passività totali 198.298 205.753 7.455 Variazione delle disponibilità liquide e mezzi equivalenti (1+2+3) 677 -152 20.967
Patrimonio netto: Effetto dei tassi di cambio sulle disponibilità liquide e mezzi equivalenti -29 -141 -194
Azioni ordinarie e capitale versato 86.939 93.718 6.779 Variazione netta delle disponibilità liquide e mezzi equivalenti 648 -293 20.773
Utili trattenuti 84.281 118.848 34.567 Disponibilità liquide e mezzi equivalenti, inizio periodo 13.576 14.224 13.931
Altre perdite complessive accumulate -4.678 -6.343 -1.665 Disponibilità liquide e mezzi equivalenti, fine periodo 14.224 13.931 34.704
Patrimonio netto totale 166.542 206.223 39.681
Totale passività e patrimonio netto 364.840 411.976 47.136
CONTO ECONOMICO MSFT
(In milioni di $, esclusi gli importi per azione)
BILANCIO MSFT (In milioni di $) FLUSSI DI CASSA MSFT (In milioni di $) PROSPETTI DEL PATRIMONIO NETTO MSFT
(In milioni di $, esclusi gli importi per azione)

All numbers in thousands 6/29/2023 6/29/2022 6/29/2021 6/29/2020
Total Revenue 211,915,000 198,270,000 168,088,000 143,015,000
Cost of Revenue 65,863,000 62,650,000 52,232,000 46,078,000
Gross Profit 146,052,000 135,620,000 115,856,000 96,937,000
Operating Expense 57,529,000 52,237,000 45,940,000 43,978,000
Operating Income 88,523,000 83,383,000 69,916,000 52,959,000
Net Non Operating Interest Income Expense 1.026.000 31.000 -215.000 89.000
Other Income 788.000 333.000 1.186.000 77.000
Pretax Income 89,311,000 83,716,000 71,102,000 53,036,000
Tax Provision 16,950,000 10,978,000 9,831,000 8,755,000
Net Income Common Stockholders 72,361,000 72,738,000 61,271,000 44,281,000
Diluted NI Available to Com Stockholders 72,361,000 72,738,000 61,271,000 44,281,000
Basic EPS 9.72 9.70 8.12 5.82
Diluted EPS 9.68 9.65 8.05 5.76
Basic Average Shares 7,446,000 7,496,000 7,547,000 7,610,000
Diluted Average Shares 7,472,000 7,540,000 7,608,000 7,683,000
Total Operating Income as Reported 88,523,000 83,383,000 69,916,000 52,959,000
Total Expenses 123,392,000 114,887,000 98,172,000 90,056,000
Net Income from Continuing & Discontinued Operation 72,361,000 72,738,000 61,271,000 44,281,000
Normalized Income 72,361,000 72,738,000 61,271,000 44,281,000
Interest Income - 2,094,000 2,131,000 2,680,000
Interest Expense - 2,063,000 2,346,000 2,591,000
Net Interest Income 1.026.000 31.000 -215.000 89.000
EBIT 88,523,000 83,383,000 69,916,000 52,959,000
EBITDA - - - -
Reconciled Cost of Revenue 65,863,000 62,650,000 52,232,000 46,078,000
Reconciled Depreciation 13,861,000 14,460,000 11,686,000 12,796,000
Net Income from Continuing Operation Net Minority Interest 72,361,000 72,738,000 61,271,000 44,281,000
Total Unusual Items Excluding Goodwill -15000 334000 1,303,000 28000
Total Unusual Items -15000 334000 1,303,000 28000
Normalized EBITDA 102,384,000 97,843,000 81,602,000 65,755,000
Tax Rate for Calcs 18.98% 13.11% 13.83% 16.51%
MSFT Income Statement

Total Assets 411,976,000 364,840,000 333,779,000 301,311,000
Current Assets 184,257,000 169,684,000 184,406,000 181,915,000
Total non-current assets 227,719,000 195,156,000 149,373,000 119,396,000
Total Liabilities Net Minority Interest 205,753,000 198,298,000 191,791,000 183,007,000
Current Liabilities 104,149,000 95,082,000 88,657,000 72,310,000
Total Non Current Liabilities Net Minority Interest 101,604,000 103,216,000 103,134,000 110,697,000
Total Equity Gross Minority Interest 206,223,000 166,542,000 141,988,000 118,304,000
Stockholders' Equity 206,223,000 166,542,000 141,988,000 118,304,000
Total Capitalization 248,213,000 213,574,000 192,062,000 177,882,000
Common Stock Equity 206,223,000 166,542,000 141,988,000 118,304,000
Capital Lease Obligations 12,728,000 11,489,000 9,629,000 7,671,000
Net Tangible Assets 128,971,000 87,720,000 84,477,000 67,915,000
Working Capital 80,108,000 74,602,000 95,749,000 109,605,000
Invested Capital 253,460,000 216,323,000 200,134,000 181,631,000
Tangible Book Value 128,971,000 87,720,000 84,477,000 67,915,000
Total Debt 59,965,000 61,270,000 67,775,000 70,998,000
Net Debt 12,533,000 35,850,000 43,922,000 49,751,000
Ordinary Shares Number 7,432,000 7,464,000 7,519,000 7,571,000
MSFT Balance Sheet
Tutti i numeri in migliaia 29/06/2023 29/06/2022 29/06/2021 29/06/2020
Totale attivo 411.976.000 364.840.000 333.779.000 301.311.000
Attività correnti 184.257.000 169.684.000 184.406.000 181.915.000
Totale attività non correnti 227.719.000 195.156.000 149.373.000 119.396.000
Totale passività Interesse netto di minoranza 205.753.000 198.298.000 191.791.000 183.007.000
Passività correnti 104.149.000 95.082.000 88.657.000 72.310.000
Totale passività non correnti Interessi netti di minoranza 101.604.000 103.216.000 103.134.000 110.697.000
Totale patrimonio netto lordo degli interessi di minoranza 206.223.000 166.542.000 141.988.000 118.304.000
Patrimonio netto degli azionisti 206.223.000 166.542.000 141.988.000 118.304.000
Capitalizzazione totale 248.213.000 213.574.000 192.062.000 177.882.000
Azioni ordinarie 206.223.000 166.542.000 141.988.000 118.304.000
Obblighi di locazione patrimoniale 12.728.000 11.489.000 9.629.000 7.671.000
Immobilizzazioni materiali nette 128.971.000 87.720.000 84.477.000 67.915.000
Capitale circolante 80.108.000 74.602.000 95.749.000 109.605.000
Capitale investito 253.460.000 216.323.000 200.134.000 181.631.000
Valore contabile tangibile 128.971.000 87.720.000 84.477.000 67.915.000
Debito totale 59.965.000 61.270.000 67.775.000 70.998.000
Debito netto 12.533.000 35.850.000 43.922.000 49.751.000
Numero Azioni Ordinarie 7.432.000 7.464.000 7.519.000 7.571.000
Stato Patrimoniale MSFT

Operating Cash Flow 87,582,000 89,035,000 76,740,000 60,675,000
Investing Cash Flow -22,680,000 -30,311,000 -27,577,000 -12,223,000
Financing Cash Flow -43,935,000 -58,876,000 -48,486,000 -46,031,000
End Cash Position 34,704,000 13,931,000 14,224,000 13,576,000
Capital Expenditure -28,107,000 -23,886,000 -20,622,000 -15,441,000
Issuance of Capital Stock 1,866,000 1,841,000 1,693,000 1,343,000
Issuance of Debt - - - 0
Repayment of Debt -2,750,000 -9,023,000 -3,750,000 -5,518,000
Repurchase of Capital Stock -22,245,000 -32,696,000 -27,385,000 -22,968,000
Free Cash Flow 59,475,000 65,149,000 56,118,000 45,234,000
Tutti i numeri in migliaia 29/06/2023 29/06/2022 29/06/2021 29/06/2020
Flusso di cassa operativo 87.582.000 89.035.000 76.740.000 60.675.000
Flusso di cassa impiegato (generato) negli investimenti -22.680.000 -30.311.000 -27.577.000 -12.223.000
Flusso di cassa impiegato (generato) nei finanziamenti -43.935.000 -58.876.000 -48.486.000 -46.031.000
Disponibilità finale di contanti 34.704.000 13.931.000 14.224.000 13.576.000
Spese in conto capitale -28.107.000 -23.886.000 -20.622.000 -15.441.000
Emissione di capitale sociale 1.866.000 1.841.000 1.693.000 1.343.000
Emissione di debito - - - 0
Rimborso del debito -2.750.000 -9.023.000 -3.750.000 -5.518.000
Riacquisto del capitale sociale -22.245.000 -32.696.000 -27.385.000 -22.968.000
Flusso di cassa libero 59.475.000 65.149.000 56.118.000 45.234.000
Flusso di Cassa MSFT
MSFT Cash Flow

Investment and Financing Decisions
Brealey-Myers-Allen
• Investment decisions are often referred to as capital budgeting or capital
expenditure ( CAPEX) decisions, because most large corporations prepare an
annual capital budget listing the major projects approved for investment.
• The choice between debt and equity financing is called the capital structure
decision. Capital refers to the firm’s sources of long-term financing.
• In some ways financing decisions are less important than investment
decisions. Financial managers say that “value comes mainly from the asset
side of the balance sheet.” In fact, the most successful corporations
sometimes have the simplest financing strategies. Take Microsoft as an
example.

Il modello tradizionale di valutazione
(Modigliani-Miller, 1961)
• Ipotesi di massimizzazione del valore di mercato di un’azienda quotata: i
managers scelgono le opzioni di investimento e finanziamento che
ritengono massimizzino il valore di mercato dell’azienda
• Il valore di un’azienda è pari al valore scontato degli utili attesi futuri
generati dagli assets posseduti, più il valore presente netto delle nuove
opportunità di investimento che coinvolgano nuove spese in conto capitale
• Per opportunità d’investimento si intende investire in progetti che hanno un
rendimento maggiore a quello del mercato  VPN positivo
• Se una azienda ha progetti con VPN positivo e annuncia nuove spese in
conto capitale (CAPEX) è molto probabile che accresca il suo valore di
mercato

The Investment Trade-off
Brealey-Myers-Allen
Assume that the financial manager is acting in the interests of the
corporation’s owners, its stockholders. What do these stockholders
want the financial manager to do? The answer depends on the rate of
return on the investment project and on the rate of return that the
stockholders can earn by investing in financial markets. If the return
offered by the investment project is higher than the rate of return
that shareholders can get by investing on their own, then the
shareholders would vote for the investment project. If the investment
project offers a lower return than shareholders can achieve on their
own, the shareholders would vote to cancel the project and take the
cash instead.

The Investment Trade-off
Brealey-Myers-Allen

Shareholders Want Managers to Maximize Market Value
Brealey-Myers-Allen
• A smart and effective manager makes decisions that increase the current value
of the company’s shares and the wealth of its stockholders. This increased
wealth can then be put to whatever purposes the shareholders want. They can
give their money to charity or spend it in glitzy nightclubs; they can save it or
spend it now. Whatever their personal tastes or objectives, they can all do more
when their shares are worth more.
• Maximizing shareholder wealth is a sensible goal when the shareholders have
access to well-functioning financial markets. Financial markets allow them to
share risks and transport savings across time. Financial markets give them the
flexibility to manage their own savings and investment plans, leaving the
corporation’s financial managers with only one task: to increase market value.

A Fundamental Result
Brealey-Myers-Allen
1. Each stockholder wants three things:
a. To be as rich as possible, that is, to maximize his or her current wealth.
b. To transform that wealth into the most desirable time pattern of consumption either
by borrowing to spend now or investing to spend later.
c. To manage the risk characteristics of that consumption plan.
2. But stockholders do not need the financial manager’s help to achieve the best time
pattern of consumption. They can do that on their own, provided they have free access
to competitive financial markets. They can also choose the risk characteristics of their
consumption plan by investing in more- or less-risky securities.
3. How then can the financial manager help the firm’s stockholders? There is only one
way: by increasing their wealth. That means increasing the market value of the firm and
the current price of its shares.

Future Value and Present Value
Brealey-Myers-Allen
Valore Futuro = 100 x (1 + r)n Valore Presente = 100 / (1 + r)n
The rate of return r is called the discount rate, hurdle rate, or opportunity cost of capital.
It is an opportunity cost because it is the return that is foregone by investing in the project rather than investing in financial markets.

The Power of Compounding: A Digression
Ross-Westerfield-Jaffe
Source: Duff&Phelps A Kroll Business / Morningstar / CFA Research Foundation
Most people who have had any
experience with compounding are
impressed with its power over long
periods.
Take the stock market, for example.
Ibbotson and Sinquefield have calculated
what the stock market returned from
1870 through 2020.
They find that one dollar placed in these
stocks at the beginning of 1870 would
have been worth $22,214.26 at the end
of 2020.
This is (1+r)^(2020-1870) = 22214,26
r = 22214,26^(1/150) - 1
r = 0,06899960
r = 6,9% compounded annual rate of
return

Compounding and Discounting

Discounting and Valuation
Grimblatt-Titmann
• Corporations create value for their shareholders by making good
real investment decisions. Real investments are expenditures that
generate cash in the future and as opposed to financial investments,
like stocks and bonds, are not financial instruments that trade in the
financial markets.
• Financial managers should use a market-based approach to value
assets, whether valuing financial assets, like stocks and bonds, or
real assets, like factories and machines.
• Essentially, a project creates value for a corporation if the cost of
investing in the project is less than the cost of investing in a portfolio
of financial assets that track the project’s future cash flows.

Discounting and Valuation
Grimblatt-Titmann
• Thus, the present value measures the worth of a project’s future cash flows at
the present time by looking at the market price of identical, or nearly identical,
future cash flows obtained from investing in the financial markets.
• To obtain a present value, you typically discount the estimated future cash flows
of a project at the rate of return of the appropriate tracking portfolio of
financial assets.
• This rate of return is known as the discount rate. As the name implies,
discounting future cash flows to the present generally reduces them.
• There are two aspects to the mechanics of discounting cash flows
• Understanding how to compute future cash flows and
• Applying the formulas that derive present values by applying discount rates to future
cash flows.

Cash Flows of Real Assets
Grimblatt-Titmann
• An ability to understand the cash flows of real assets is an essential skill for the
analysis of a real investment decision.
• The cash flows of an asset are represented as numbers attached to dates in
time, with date 0 generally referring to the current date.
• The sign of the cash flow tells the analyst whether the cash flow is an inflow or
an outflow.
• The cash flow numbers can be obtained from pro-forma cash flow statements
or derived from earnings.
• The cash flows of projects or firms can come directly from the real assets of the
project or firm, or indirectly, via financing subsidies that the project or firm
manages to garner, notably the tax subsidy associated with debt financing and
relocation subsidies.

Estimating Cash Flows on an Incremental Basis
Brealey-Myers-Allen
• The value of a project depends on all the additional cash flows that follow
from project acceptance
• Do Not Confuse Average with Incremental Payoffs
• Include All Incidental Effects
• Forecast Sales Today and Recognize After-Sales Cash Flows to Come Later
• Do Not Forget Working Capital Requirements
• Include Opportunity Costs
• Forget Sunk Costs
• Beware of Allocated Overhead Costs
• Remember Salvage Value matteo.marcantognini@gmail.com

Incremental Cash Flows
Ross-Westerfield-Jordan
• The incremental cash flows for project evaluation consist of all changes in the firm’s future
cash flows that are a direct consequence of taking the project.
• Be careful to exclude sunk costs from project valuation
• Consider the opportunity cost
• Remember that the incremental cash flows for a project include all the resulting changes
in the firm’s future cash flows
• Normally a project will require that the firm invest in net working capital in addition to
long-term assets
• The firm supplies working capital at the beginning and recovers it toward the end
• In analyzing a proposed investment, we will not include interest paid or any other
financing costs such as dividends or principal repaid because we are interested in the cash
flow generated by the assets of the project

Unlevered Cash Flows
Grimblatt-Titmann
• When evaluating a project, one must first identify the project’s unlevered cash flows,
that is, cash flows generated directly from the real assets of the project or firm.
• In a hypothetical world where financing does not affect the operations of a project,
unlevered cash flows are the cash flows from the project’s (or firm’s) assets under the
assumption that the project (or firm) is all-equity financed.
• The unlevered cash flows, generated entirely by real assets, like a power plant, are
not affected by and should not be confused with any financing cash flows, which are
associated with (1) issuance or retirement of debt and equity, (2) interest or dividend
payments, and (3) any interest-based tax deductions that stem from debt financing.
• One derives unlevered cash flows from forecasts of cash flow statements or, more
often, from forecasts of earnings before interest and taxes, more commonly known as
EBIT.

Deriving Unlevered Cash Flows from the Accounting Cash Flow Statement
Grimblatt-Titmann
• Accounting cash flow statements break up the cash flow into the sum of
operating cash flows, investing cash flows, and financing cash flows.
• Operating cash flow, in the accounting sense, does not properly account for
cash flows that stem directly from the firm’s operations
• Operating cash flows, unlike unlevered cash flows, also do not account for the
required capital expenditures that a firm or project may require to keep it
operating.
• To obtain unlevered cash flows from the cash flow statement, you must add the
operating and investing cash flow, add interest, and then subtract the tax
subsidy provided by debt interest, as the following result indicates.
• Unlevered cash flow = operating cash inflow + investing cash inflow (which is
usually negative) + debt interest - debt interest tax subsidy

Interest Expense
• Interest expense: many projects are at least partially financed with debt.
• As it turns out, an approach of assuming no debt financing is rather
standard in the real world.
• Firms typically calculate a project’s cash flows under the assumption that
the project is financed only with equity.
• Any adjustments for debt financing are reflected in the discount rate,
not the cash flows.
• The treatment of debt in capital budgeting will be covered in depth in the
Cost of Capital and WACC topics
• The Weighted Average Cost of Capital of a company is the appropriate
discount rate to value its assets and new projects

Cash Flows of Real Assets
Grimblatt-Titmann
• To value assets, it is important to value only those cash flows that
are generated by the assets. Since financing takes place on the right-
hand side rather than on the lefthand (asset) side of the balance
sheet, counting financing cash flows in addition to asset cash flows
would involve double counting cash flows. As financing activities per
se play no role in increasing or decreasing the cash flows generated
by the assets of the project, counting them in an asset valuation
would be inappropriate. A notable exception arises when there is an
obvious and easily measured subsidy, associated with financing,
such as a tax subsidy, which can be ascribed to the asset being
valued.

Deriving Unlevered Cash Flow from EBIT
Grimblatt-Titmann
•Unlevered cash flow = EBIT +
depreciation and amortization -
change in working capital - capital
expenditures + sales of capital assets -
realized capital gains + realized capital
losses – EBIT*tax rate

Creating Pro-Forma Forecasts of Financial Statements
Grimblatt-Titmann
• Cash flow forecasts are usually derived from forecasts of financial
statements
• Assumptions: Sales, Expenses, Financing, Dividends, and Interest Rates
• Income Statement: Cost of Sales, EBIT, Interest, Taxes, and Other Items
• Cash Flow Statement
• Balance Sheet Assets: Cash, Accounts Receivable and Inventories, PPE,
and Other Items
• Balance Sheet Liabilities: Debt, Current Liabilities, Deferred Taxes, and
Other Items
• Balance Sheet Equity

Cash Flow Projections
Cash Flow Projections
SDA Bocconi
Year 1 Year 2 Year 3 Year 4
Sales 49.860,00 52.756,00 56.698,00 61.721,00
Operating costs 39.379,00 40.910,00 43.782,00 45.714,00
EBITDA 10.481,00 11.846,00 12.916,00 16.007,00
Depreciation 1.768,00
- 2.305,00
- 2.305,00
- 2.388,00
-
EBIT 8.713,00 9.541,00 10.611,00 13.619,00
Other income - - - -
Interest expenses 300,00
- 36,00
- 36,00
- 36,00
-
EBT 8.413,00 9.505,00 10.575,00 13.583,00
Taxes 1.648,00
- 4.074,00
- 4.378,00
- 5.710,00
-
NET INCOME 6.765,00 5.431,00 6.197,00 7.873,00
Profits & losses statement: expected (€/000)
Year 1 Year 2 Year 3 Year 4
(+) EBIT 8.713,00 9.541,00 10.611,00 13.619,00
(-) Income Taxes 1.648,00
- 4.074,00
- 4.378,00
- 5.710,00
-
(+) Depreciation 1.768,00 2.305,00 2.305,00 2.388,00
(-) Increase net working capital 9.788,00
- 4.500,00
- 500,00
- 500,00
-
(-) Capex 3.000,00
- 3.975,00
- 1.322,00
- 500,00
-
CASH FLOW 3.955,00
- 703,00
- 6.716,00 9.297,00
Cash flow statement: expected (€/000)

A Note on Net Working Capital
• The investment in net working capital is an important part of any capital budgeting analysis.
• An investment in net working capital arises whenever (1) raw materials and other inventory
are purchased prior to the sale of finished goods, (2) cash is kept in the project as a buffer
against unexpected expenditures, and (3) credit sales are made, generating accounts
receivable rather than cash.
• This investment in net working capital represents a cash outflow, because cash generated
elsewhere in the firm is tied up in the project.
• Typically, corporate worksheets treat net working capital as a whole. The individual
components of working capital (receivables, inventory, etc.) do not generally appear in the
worksheets
• However, the working capital numbers in the worksheets are not pulled out of thin air.
• Rather, they result from a meticulous forecast of the components.

Tecniche di Valutazione degli Investimenti in Progetti
Carlos Molina IESA Business School
• Valore Presente Netto = Valore
Attuale Netto VPN = VAN
• Payback Period e Discounted
Payback Period
• Internal Rate of Return IRR
• Profitability Index = VP /
Investimento
• Si devono considerare tutti i FC,
sia inflows sia outflows
• Tutti i flussi si devono scontare al
costo opportunità
• Dev’essere possibile scegliere fra
mutually exclusive projects
• Ogni progetto dev’essere
analizzato indipendentemente fra
gli altri progetti

Calculating Present Values When There Are Multiple Cash Flows
Brealey-Myers-Allen

Annuities and
Perpetuities
Brealey-Myers-Allen

The NPV Algebraic Formula

Valuing a Project
Wharton Business School Penn University
PORTLOT PROJECT
Project Assumptions 0 1 2 3 4 5
Revenue Forecasts
Market Forecasts
Initial Market Size Market (units, million) 240,00
Growth Rate 20,00% 20,0% 20,0% 20,0%
Market Size (Units, million) 240,0 288,0 345,6 414,7 497,7
Corp Market Share 30%
Initial Market Share = 0.3Snapdeal*0.01Portlot 0,30%
Market Share Annual Growth 20,00% 15,00% 10,00% 5,00%
Market Share 0,3% 0,4% 0,4% 0,5% 0,5%
Pricing Strategy
Initial Unit Price ($/Unit) 9,99
Bi-Annual Price Increases ($/Unit) 0,99 0,99
Unit Price ($/Unit) 9,99 9,99 10,98 10,98 11,97
Incremental Earnings Forecasts 0 1 2 3 4 5
Sales 7,19 10,36 15,71 20,74 28,48
Year

Valuing a Project
Operating Expenses
COGS 66,67% 66,67% 66,67% 66,67% 66,67% 66,67%
COGS/SALES (%Sales)
SG&A
1% of 2015 Company SG&A 1
SG&A Expense Growth Rate 25,00% 25,00% 25,00% 25,00%
R&D
R&D Upfront ($mil) 1,00
R&D for Versioning ($mil) 0,10 0,10 0,10 0,10 0,10
COGS 4,80 6,91 10,47 13,83 18,99
SG&A 1,00 1,25 1,56 1,95 2,44
R&D 1,00 0,10 0,10 0,10 0,10 0,10

Valuing a Project
Capital Expenditures & PP&E & Software Information
Initial Investment (Fixed Cost, $mil) 1
Future Investment (% of initial Investment) 0,0%
Future Investment (Annual Growth) 0,0% 0,0% 0,0% 0,0%
PP&E (Software) Liquidation Value 50,00% 50,0% 50,0% 50,0% 50,0% 50,0%
PP&E (Software) Life for depreciation ( amortization / Years) 5,00 5 5 5 5 5
Capital Expenditures Forecasts 0 1 2 3 4 5
Project CapEx 1,00 0 0,00 0,00 0,00 0,00
Accumulated CapEx 1,00 1,00 1,00 1,00 1,00 1,00
Depreciation + Software Amortization 0,20 0,20 0,20 0,20 0,20
Book Value of CapEx 0,00
Liquidation Value 0,00
After tax proceeds from asset sale (MTR 25,5%) 0,00
Net Project CapEx 1,00 0,00 0,00 0,00 0,00 0,00

Valuing a Project
Working Capital Assumptions
Cash Requirements
% of SG&A 50,00% 50,00% 50,00% 50,00% 50,00% 50,00%
% R&D Expenditures 100,00% 100,00% 100,00% 100,00% 100,00% 100,00%
Inventory
Inventory Days (365 x Inventory / COGS) 30 30 30 30 30 30
Excess Inventory liquidation value (% of Inventory Cost) 25,00%
Accounts Receivable
Days Receivable (365 x Accounts Receivable / Sales) 30 30 30 30 30 30
Accounts Payable
Days Payable (365 x Accounts Payable /COGS) 60 60 60 60 60 60

Valuing a Project
Working Capital Forecasts 0 1 2 3 4 5
Cash Requirements - SG&A Funding 0,50 0,63 0,78 0,98 1,22
Cash Requirements - R&D Funding 0,1 0,1 0,1 0,1 0,1
Cash 0,60 0,73 0,88 1,08 1,32
Inventory 0,39 0,57 0,86 1,14 1,56
Accounts Receivable 0,59 0,85 1,29 1,70 2,34
Accounts Payable 0,79 1,14 1,72 2,27 3,12
Net Working Capital 0,00 0,80 1,01 1,31 1,64 2,10
Recovered NWC at end of Project -0,93
Change in NWC 0,80 0,21 0,30 0,33 -0,47

Valuing a Project
Sales 7,19 10,36 15,71 20,74 28,48
COGS 4,80 6,91 10,47 13,83 18,99
Gross Profit 0,00 2,40 3,45 5,24 6,91 9,49
SG&A 1,00 1,25 1,56 1,95 2,44
R&D 1,00 0,10 0,10 0,10 0,10 0,10
EBITDA -1,00 1,30 2,10 3,57 4,86 6,95
EBIT -1,00 1,10 1,90 3,37 4,66 6,75
Taxes 30% -0,30 0,33 0,57 1,01 1,40 2,03
NOPAT (aka EBIAT, Unlevered Net Income) -0,70 0,77 1,33 2,36 3,26 4,73
Free Cash Flow Forecasts 0 1 2 3 4 5
NOPAT (aka EBIAT, Unlevered Net Income) -0,70 0,77 1,33 2,36 3,26 4,73
Capital Expenditures 1,00 0,00 0,00 0,00 0,00 0,00
Changes in NWC 0,80 0,21 0,30 0,33 -0,47
Free Cash Flows -1,70 0,17 1,32 2,26 3,13 5,40

Valuing a Project
Net Present Value 0 1 2 3 4 5
Hurdle Rate Cost of Capital R 25% 25% 25% 25% 25% 25%
Free Cash Flows -1,70 0,17 1,32 2,26 3,13 5,40
Discounted Free Cash Flows -1,70 0,14 0,84 1,16 1,28 1,77
NPV USD Million -1,70 -1,56 -0,72 0,44 1,72 3,49
IRR 72,18%
PayBackPeriod 0 1 2 3 4 5
Free Cash Flows -1,70 0,17 1,32 2,26 3,13 5,40
Cumulative Free Cash Flows -1,70 -1,53 -0,21 2,05 5,18 10,58
PBP years 3
DiscountedPayBackPeriod 0 1 2 3 4 5
Discounted Free Cash Flows -1,70 0,14 0,84 1,16 1,28 1,77
Cumulative Discounted Free Cash Flows -1,70 -1,56 -0,72 0,44 1,72 3,49
DPBP Slope Method YEAR 2,62

Value Additivity Property
Grimblatt-Titmann
• Value additivity implies that the value of a firm after project
adoption is the present value of the firm’s cash flows from existing
projects, plus cash for future investment, plus the net present value
of the adopted project’s cash flows.
• The value additivity property makes it easy to understand how to
properly select the best project from among a group of projects that
are mutually exclusive.
• Given a set of investment projects, each with positive NPV, one
should select the project with the largest positive NPV if allowed to
adopt only one of the projects.

The key to NPV is its three attributes:
1. NPV Uses Cash Flows  Cash flows from a project can be used for
other corporate purposes (e.g., dividend payments, other capital-
budgeting projects, or payments of corporate interest). By contrast,
earnings are an artificial construct. While earnings are useful to
accountants, they should not be used in capital budgeting because they
do not represent cash.
2. NPV Uses All the Cash Flows of the Project  Other approaches ignore
cash flows beyond a particular date; beware of these approaches.
3. NPV Discounts the Cash Flows Properly  Other approaches may
ignore the time value of money when handling cash flows. Beware of
these approaches as well.

The payback period rule
• The payback period rule for making investment decisions is simple.
• Consider a project with an initial investment of -$50,000. Cash flows are
$30,000, $20,000, and $10,000 in the first three years, respectively
• The firm receives cash flows of $30,000 and $20,000 in the first two years,
which add up to the $50,000 original investment.
• This means that the firm has recovered its investment within two years.
• In this case two years is the payback period of the investment.
• There are at least three problems with the payback method:
• Problem 1: Timing of Cash Flows within the Payback Period
• Problem 2: Payments after the Payback Period
• Problem 3: Arbitrary Standard for Payback Period

The discounted payback period rule
• Under this approach, we first discount the cash flows.
• Then we ask how long it takes for the discounted cash flows to equal
the initial investment.
• VP = Investment   Formula given
by Carlos Molina
• The discounted payback period of the original investment is simply
the payback period for these discounted cash flows.
• It has some of the same major flaws as the payback:
• it has some of the same major flaws as the payback.
• it ignores all the cash flows after that date.

The average accounting return
• The average accounting return is the average project earnings after
• taxes and depreciation, divided by the average book value of the
investment during its life.
• Despite its flaws, the average accounting return method is worth
examining because it is used frequently in the real world.
• Step One: Determining Average Net Income
• Step Two: Determining Average Investment
• Step Three: Determining AAR
• AAR = ANI / AI

Projected Yearly Revenue and Costs for Average
Accounting Return

Net Present Value and Internal Rate of Return IRR
Brealey-Myers-Allen
• Net present value equals present value minus the required
investment: NPV = PV – investment
• The rate of return is simply: Return = NPV / investment = C1/-C0 – 1
• IRR = is the discount rate that gives a zero NPV  NPV = C0 + C1 /
(1+discount rate) = 0  Discount rate = C1/-C0 – 1
• We have two equivalent decision rules for capital investment:
• Net present value rule. Accept investments that have positive net present
values.
• Rate of return rule. Accept investments that offer rates of return more than
their opportunity costs of capital.

The internal rate of return rule
The internal rate of return
• The most important alternative to the NPV
approach.
• In general, the IRR is the rate that causes the
NPV of the project to be zero.
• The basic IRR rule: accept the project if IRR is
greater than the discount rate; reject the
project if IRR is less than the discount rate.
• Algebraically, IRR is the unknown in the
following equation:
• 𝟎 = −𝑰𝟎 +
𝑪𝑭𝒕=𝟏
𝟏+𝑰𝑹𝑹
+
𝑪𝑭𝒕=𝟐
𝟏+𝑰𝑹𝑹 𝟐 + ⋯ +
𝑪𝑭𝒕=𝑻
𝟏+𝑰𝑹𝑹 𝑻
• It should also be clear that the NPV is positive
for discount rates below the IRR and negative
for discount rates above the IRR.

Problemi con l’IRR
Carlos Molina IESA School of Management
• Problema #1: se ci finanziamo dobbiamo tenere conto che l’IRR
dev’essere minore al tasso del prestito
• Problema #2: se i CF cambiano di segno, vi saranno tanti IRR quanti i
cambiamenti di segno dei CF (ad es. outflow  inflow  outflow  2
IRR)
• Problema #3: se usiamo entrambi i criteri NPV e IRR possiamo avere dei
problemi di decisione per scegliere fra progetti mutuamente escludenti
• Problema #4: se il tasso di sconto cambia di periodo in periodo e
dovuto alla struttura a termine dei tassi, cambia il paragone con l’IRR

Problem #1: Investing or Financing?

Problem #2: Nonconventional Cash Flows?
• Suppose we have a strip-mining project that requires a $60
investment. Our cash flow in the first year will be $155. In the
second year, the mine will be depleted, but we will have to spend
$100 to restore the terrain.
• To fi nd the IRR on this project, we can calculate the NPV at various
rates: The NPV appears to be behaving in a peculiar fashion here.
First, as the discount rate increases from 0 percent to 30 percent,
the NPV starts out negative and becomes positive. This seems
backward because the NPV is rising as the discount rate rises. It
then starts getting smaller and becomes negative again.
• The moral of the story is that when the cash fl ows aren’t
conventional, strange things can start to happen to the IRR. This is
not anything to get upset about, however, because the NPV rule,
as always, works just fi ne. This illustrates the fact that, oddly
enough, the obvious question—What’s the rate of return?—may
not always have a good answer.

Problem #3: Mutually exclusive projects
• Even if there is a single IRR, another problem
can arise concerning mutually exclusive
investment decisions . If two investments, A
and B, are mutually exclusive, then taking one
of them means that we cannot take the other.
• Remember, we’re ultimately interested in
creating value for the shareholders, so the
option with the higher NPV is preferred,
regardless of the relative returns.
• The crossover rate, by definition, is the
discount rate that makes the NPVs of two
projects equal.
• In general, you can find the crossover rate by
taking the difference in the cash flows and
calculating the IRR using the difference. It
doesn’t make any difference which one you
subtract from which.

Problem #3: Mutually exclusive projects

Profitability Index
Grimblatt-Titmann
• An extension of the net present value rule known as the profitability index,
which is the present value of the project’s future cash flows divided by -C0,
the negative of the initial cash flow, which is the initial cost of the project.
• In the absence of a capital constraint, the value maximizing rule with the
profitability index is one that adopts projects with a profitability index
greater than 1 if C0 is negative  PV/-C0 > 1.
• The profitability index can be particularly useful if C0 is negative for all
projects under consideration and if there is a capital constraint in the initial
period.
• The project with the largest profitability index exceeding 1 is the best.

The Profitability Index or benefit/cost ratio
• It is the ratio of the present value of the future expected cash flows after initial investment
divided by the amount of the initial investment  NPV/Investment
• If a project has a positive NPV, then the present value of the future cash flows must be
bigger than the initial investment.
• The profitability index would thus be bigger than 1 for a positive NPV investment and less
than 1 for a negative NPV investment.
• Independent Projects: Accept an independent project if PI > 1 and Reject if PI<1.
• Mutually Exclusive Projects: Because the profitability index on the incremental cash flows
is greater than 1.0, we should choose the bigger project, that is, the project that has the
bigger NPV.
• Capital Rationing: In the case of limited funds, we cannot rank projects according to their
NPVs. Instead, we should rank them according to the ratio of present value to initial
investment. This is the PI rule. matteo.marcantognini@gmail.com

Investing in Risk-Free Projects
Grimblatt-Titmann
• When the cash flows of a project are riskless, they can be tracked perfectly with a
combination of default-free bonds.
• The per-period yield-to-maturity of a zero-coupon bond is the discount rate.
• A project’s discounted cash flow is the sum of all the discounted future cash flows plus
today’s cash flow, which is usually negative, since it represents the initial expenditure
needed to start the project.
• The discounted cash flow of the project is: DCF = C0 + C1/(1 + r1) + C2/(1 + r2)^2 + . . . + CT/(1 + rT)^T
• These discount rates, often referred to as the costs of capital (or costs of financing), are the yields-to-
maturity of default-free zero-coupon bonds.
• The wealth maximizing net present value criterion is that:
• All projects with positive net present values should be accepted.
• All projects with negative net present values should be rejected.

Investing in Risky Projects
Grimblatt-Titmann
• The way one forecasts cash flows determines the discount rate used to obtain present values.
• This task, is much more difficult for risky investments because (1) the manager needs to know
what it means to forecast cash flows when they are risky, and (2) identifying the appropriate
discount rate is more complex when cash flows are risky.
• Each expected cash flow, generated as the probability-weighted sum of the cash flow in each
of a variety of scenarios, could then be discounted with a risk-adjusted discount rate
determined by a risk-return model like the CAPM or the APT.
• Obtaining PVs in this fashion is known as the risk adjusted discount rate method.
• Since the expected cash flows are generated by assets that we are trying to value, it is
important to find their present values by discounting them at the expected returns of assets
that are comparable to the assets being valued.
• These typically are the assets of publicly traded firms in the same line of business as the asset
being valued. matteo.marcantognini@gmail.com

The Practice of Capital Budgeting
• Recall that we are trying to make an investment decision and that we are
frequently operating under considerable uncertainty about the future.
• We can only estimate the NPV of an investment.
• Because the true NPV is unknown, the astute financial manager seeks clues to
help in assessing whether the estimated NPV is reliable.
• For this reason, firms would typically use multiple criteria for evaluating a
proposal.
• The use of quantitative techniques in capital budgeting varies with the industry.
• As one would imagine, firms that are better able to precisely estimate cash
flows are more likely to use NPV.

NPV and Capital Budgeting  Capital Investment Decisions
• There are many differences between earnings and cash flows.
• When valuing the firm, we discounted dividends—not earnings—because dividends are the
cash flows that an investor receives.
• When considering a single project, we discounted the cash flows that the firm receives
from the project.
• In addition, it is not enough to use cash flows.
• In calculating the NPV of a project, only cash flows that are incremental to the project
should be used.
• These cash flows are the changes in the firm’s cash flows that occur as a direct
consequence of accepting the project.
• That is, we are interested in the difference between the cash flows of the firm with the
project and the cash flows of the firm without the project.

Sunk Costs / Opportunity Costs / Side Effects
• A sunk cost is a cost that has already occurred. Because sunk costs are in the past,
they cannot be changed by the decision to accept or reject the project. Just as we “let
bygones be bygones,” we should ignore such costs. Sunk costs are not incremental
cash outflows.
• Your firm may have an asset that it is considering selling, leasing, or employing
elsewhere in the business. If the asset is used in a new project, potential revenues
from alternative uses are lost. These lost revenues can meaningfully be viewed as
costs. They are called opportunity costs because, by taking the project, the firm
forgoes other opportunities for using the assets.
• Another difficulty in determining incremental cash flows comes from the side effects
of the proposed project on other parts of the firm. The most important side effect is
erosion. Erosion is the cash flow transferred to a new project from customers and
sales of other products of the firm.

Analyzing a Project from
Proforma Financial
Statements to NPV
Firms typically calculate a
project’s cash flows under the
assumption that the project is
financed only with equity.
Any adjustments for debt
financing are reflected in the
discount rate, not the cash
flows.
These CF are unlevered.

Incremental
Cash
Flows
Boeing
777

Inflation and Capital Budgeting
• Inflation is an important fact of economic life, and it must be considered in
capital budgeting.
• 1 + Nominal Interest Rate = (1 + Real Interest Rate) x (1 + Inflation Rate)
• Nominal Interest Rate = [(1 + Real Interest Rate) x (1 + Inflation Rate)] – 1
• Real Interest Rate = [(1 + Nominal Interest Rate) / (1 + Inflation Rate)] – 1
• Similarly, cash flows can be expressed in either nominal or real terms.
• Nominal cash flows must be discounted at the nominal rate.
• Real cash flows must be discounted at the real rate.

The Equivalent Annual Cost Method
• Suppose a firm must choose between two machines of unequal lives.
• Both machines can do the same job, but they have different operating costs
and will last for different time periods.
• A simple application of the NPV rule suggests that we should take the
machine whose costs have the lower present value.
• This could lead to the wrong decision, though, because the lower-cost
machine may need to be replaced before the other one.
• If we are choosing between two mutually exclusive projects that have
different lives, the projects must be evaluated on an equal-life basis.
• In other words, we must devise a method that considers all future
replacement decisions. matteo.marcantognini@gmail.com

Choosing between Long- and Short-Lived Equipment
Brealey-Myers-Allen

Equivalent Annual Cash Flows and Inflation
Brealey-Myers-Allen

Equivalent Annual Cost and Operating Leasing
SDA Bocconi
0 1 2 3 4
Cash flows A 40000 10000 10000 10000
PV Cash flows A 40000,0 9434,0 8900,0 8396,2
Cash flows B 50000 8000 8000 8000 8000
PV Cash flows B 50000,0 7547,2 7120,0 6717,0 6336,7
Annuity Factor - 3 years 2,67
Annuity Factor - 4 years 3,47
Equivalent Annual Cost A 24.964,39
Equivalent Annual Cost B 22.429,57
b. Which machine should Borstal buy? B
c. How much would you actually have to charge in each future year if there is steady 8% per year inflation?
26.961,54
Year Machine A Machine B
0 $40.000 $50.000
1 10.000 8.000
2 10.000 8.000
3 10,000 + replace 8.000
4 8,000 +replace
These costs are expressed in real terms.
b. Which machine should Borstal buy?
The Borstal Company has to choose between two machines that do the same job but
have different lives. The two machines have the following costs:
a. Suppose you are Borstal’s financial manager. If you had to buy one or the other
machine and rent it to the production manager for that machine’s economic life,
what annual rental payment would you have to charge? Assume a 6% real discount
rate and ignore taxes.
c. Usually the rental payments you derived in part (a) are just hypothetical—a way
of calculating and interpreting equivalent annual cost. Suppose you actually do
buy one of the machines and rent it to the production manager. How much would
you actually have to charge in each future year if there is steady 8% per year inflation?
Note: The rental payments calculated in part (a) are real cash flows. You
would have to mark up those payments to cover inflation.

Strategy and Analysis in Using Net Present Value
• The process of asking about the sources of positive NPV in capital budgeting
is often referred to as corporate strategy analysis.
• The intuition behind discounted cash flow analysis is that a project must
generate a higher rate of return than the one that can be earned in the
capital markets.
• Only if this is true will a project’s NPV be positive.
• A significant part of corporate strategy analysis is seeking investment
opportunities that can produce positive NPV.
• For shareholders, CEOs, CMO,s and CFOs must be able to point to the
specific sources of positive increments to present value in doing discounted
cash flow analysis. matteo.marcantognini@gmail.com

Ways to create Positive Net Present Value
1. Be the first to introduce a new product.
2. Further develop a core competency to
produce goods or services at lower cost than
competitors.
3. Create a barrier that makes it difficult for
other firms to compete effectively.
4. Introduce variations on existing products to
take advantage of unsatisfied demand.
5. Create product differentiation by aggressive
advertising and marketing networks.
6. Use innovation in organizational processes
to do all of the above.

Corporate Strategy and the Stock Market
• There should be a connection between the stock market and capital budgeting.
• If a firm invests in a project that is worth more than its cost, the project will produce
positive NPV, and the firm’s stock price should go up.
• However, the popular financial press frequently suggests that the best way for a firm to
increase its share price is to report high short-term earnings.
• Therefore, some firms tend to reduce capital expenditures and research and
development to increase short-term profits and stock prices.
• Some papers like the McConnell and Muscarella research suggests that the stock market
does pay close attention to corporate capital spending, and it reacts positively to firms
making long-term investments.
• In another highly regarded study, Woolridge found a strong positive stock reaction to
firms’ announcements of joint ventures, research and development spending, new-
product strategies, and capital spending for expansion and modernization.

The Capital Investment Process
Brealey-Myers-Allen
• Senior management needs some forewarning of future investment outlays.
• So, for most large firms, the investment process starts with the preparation of an annual
capital budget, which is a list of investment projects planned for the coming year.
• Most firms let project proposals bubble up from plants for review by divisional
management and then from divisions for review by senior management and their
planning staff.
• Preparation of the capital budget is not a rigid, bureaucratic exercise.
• Divisional managers negotiate with plant managers and fine-tune the division’s list of
projects.
• The final capital budget must also reflect the corporation’s strategic planning.
• Strategic planning takes a top-down view of the company.

Sensitivity and Scenario Analysis
Brealey-Myers-Allen
• Sensitivity analysis boils down to expressing cash flows in terms of key project variables and then calculating
the consequences of misestimating the variables.
• It forces the manager to identify the underlying variables, indicates where additional information would be
most useful, and helps to expose inappropriate forecasts.
• Conduct a sensitivity analysis with respect to market size, market share, and so on.
• To do this, the marketing and production staffs are asked to give optimistic and pessimistic estimates for the
underlying variables.
• To undertake a sensitivity analysis a project, we set each variable in turn at its most pessimistic or optimistic
value and recalculate the NPV of the project.

Break-Even Analysis
Brealey-Myers-Allen

Real Options and Decision Trees
Brealey-Myers-Allen
• When you use discounted cash flow (DCF) to
value a project, you implicitly assume that the
firm will hold the assets passively.
• If things go well, the project may be expanded; if
they go badly, the project may be cut back or
abandoned altogether.
• Projects that can be modified in these ways are
more valuable than those that do not provide
such flexibility.
• The more uncertain the outlook, the more
valuable this flexibility becomes.
• Options to modify projects are known as real
options.

Allocating Capital and Corporate Strategy
Grimblatt-Titmann
1. Identify the sources of positive net present value.
2. Implement the real options approach to value projects, the options
inherent in mines and vacant land, and the options to wait or to
expand a project. Know the effect of these options on a firm’s choice
to diversify and select different production techniques from its
competitors.
3. Use the ratio comparison approach to value real assets, and in the
case of price/earnings ratios, how to adjust the ratio to make
appropriate comparisons between firms with different leverage ratios.
4. Compare the virtues and pitfalls of the competitive analysis
approach to evaluate real investments and know how to apply it.

Allocating Capital and Corporate Strategy
Grimblatt-Titmann
• The real options approach, which refers to the application of the
derivatives valuation methodology to value real assets.
• The ratio comparison approach, which values an investment at
approximately the same ratio of value to a salient economic variable
as an existing comparable investment for which the same ratio is
observable.
• The competitive analysis approach, which attributes positive net
present value to any project of a firm that can identify its
competitive advantages and a negative NPV to any project where
competitors have the advantages.

Valuing Strategic Options with the Real Options Methodology
Grimblatt-Titmann
• The valuation of natural resource
investments (for example, oil wells
and copper mines) illustrates how to
implement the real options
approach:
• A mine with no strategic options.
• A mine with an abandonment option.
• Vacant land.
• The option to delay the start of a
project.
• The option to expand capacity.
• Flexibility in production technology.

Valuing Vacant Land
Grimblatt-Titmann
• Vacant land has value because it represents an option to turn the vacant land into developed land.
• For example, a particular plot of land may be developed into condominiums, an office building, or a shopping mall.
• In the future, the developer will have an incentive to develop the property for the use that maximizes the
difference between the value of the project’s future revenues and its construction costs.
• However, the best possible future use for the land may not be known at the present time.
• The real options approach can be used to determine the worth of an option to construct one of a number of
possible buildings with strike prices equal to the building’s construction costs.
• One can value this option, and thus the land, by first computing the risk-neutral probabilities associated with
various outcomes.
• Titman (1985), uses the binomial approach to obtain the risk-neutral probabilities necessary to value vacant land.
One derives these probabilities from the observed market prices of traded investments.
• Calculating these risk-neutral probabilities requires solving for probabilities that generate expected cash flows for
traded assets that equal their certainty equivalent cash flows.
• In other words, with the correct risk-neutral probabilities, the expected cash flows of traded assets, discounted at
the risk-free rate, will equal the observed market price of the traded asset.
• These same risk-neutral probabilities can then be applied to the cash flows of the investment being valued to
calculate the risk-neutral (or certainty equivalent) cash flows, which are then discounted at the risk-free rate.

Project_Valuation.ppsx

Recommended

Recommended

More Related Content

Similar to Project_Valuation.ppsx

Similar to Project_Valuation.ppsx (20)

More from Matteo Marcantognini Palacios

More from Matteo Marcantognini Palacios (17)

Recently uploaded

Recently uploaded (20)

Project_Valuation.ppsx