Unit 5 Intellipath Notes Project Valuation

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Colorado Technical University *

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Finance

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Jan 9, 2024

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Introduction Modern finance, the growth of technology, and globalization have all played a role in the way that businesses value projects. In turn, what is defined as a project has fundamentally changed the way corporations are born, funded, and transformed. Generally, the reason for valuing projects is to rank several projects and provide a common method to decide which projects represent the best use of corporate funds. The internal rate of return method and the net present value method are used in this process. Rather than being organized as older manufacturing- oriented department-focused entities, corporations today are structured around specific resources, people, and fluid project teams. Learning Materials Project valuation looks at the many different ways to value an individual project (Bierman & Smidt, 2006). The project is measured by its internal cash flows and the initial cash outlay at the beginning of that project. Cash flows from a project are affected by both external and internal forces (Shaeffer, 2002). Obviously, the nature of the project itself, how well the expected cash flows have been determined, and the effectiveness of the project manager in running that project are all significant contributing factors to the success or failure of the undertaking. Naturally, a discounted cash flow method will be used to calculate the future value of the project. The starting point is arriving at the after-tax cash flows. First, a sales projection is created based on reasonable assumptions about the ability of the corporation to generate positive sales cash flows from the project. The second step is to determine all reasonable expenses for the duration of the project. The third step is to determine the amount of depreciation, if any, that can be used to reduce tax liabilities. The fourth step is the calculation of the tax liability. Once this is completed, the amount of deprecation taken in the third step is added back in to arrive at the net after-tax cash flow (Gitman, 2006). The final step is to analyze the net after-cash flows of the project that is calculated for the end of each year of the projected life of that project, and this is done by using either the internal rate of return (IRR) method or the net present value (NPV) method. Both methods are used frequently. In the IRR method, the yield from the project is determined by equating the interest rate that equals the cash flows both in and out of the company (Block, Hirt, & Danielsen, 2009). In the NPV method, the net after-tax cash flows expected to be generated by the project are modified by the net present value factor, summing them, and then subtracting the initial investment outlay (Block et al., 2009). The corporation should select the project that will generate the highest yield or return in profit to the company. Projects and their valuations are central to the modern view of structuring the financial dealings of a corporation (Bierman & Smidt, 2006). Corporations are moving away from the traditional configuration of functional departments, a structure that was largely a manufacturing organizational structure; corporations have embraced a project-oriented organizational arrangement that is both fluid and adaptable. The emphasis shifts from a production domain to a project one where the uniqueness of the project drives the corporate hierarchy structure, not the other way around. Functional departments,

such as accounting and shipping, do not exist as formal departments, but the expertise of an accountant or shipping specialist is utilized as needed to fulfill the needs of the project (Bierman & Smidt, 2006). The project can be of any nature; it can be a product or product line, a marketing plan or a new subsidiary company, or even the strategic positioning of the corporation in a new market, either domestic or foreign. Because of this reconfiguration of strategic corporate thinking, the methods used to value projects have become more important than ever, even if they are not always reflected in actual corporate structure. To be sure, the basics of valuing a project, regardless of its nature, are still grounded in an understanding of the time value of money and the use of the net present value to modify the after- tax cash flows that are expected to be earned (Shim & Siegel, 1992; Dauber, Siegel, & Shim, 1996; Gitman, 2006; Block et al., 2009). Projects can be packaged as investments. As such, they can be set up as separate ventures and marketed on their own as securities (Gitman, Joehnk, & Smart, 2011). The use of the corporate shell to facilitate this type of investment vehicle offers certain advantages to the company in terms of raising capital. In this case, the corporation serves to bring together the human resources that can be organized into project teams, and the teams then can run those projects almost as separate profit-and-loss entities. Modern corporations should be more creative when raising capital, such as with projects as investments that can expand long-term growth opportunities (Kodukula & Papuesey, 2006). Projects are the investment vehicles of the future; they not only change how corporations are capitalized, but also alter the way corporations are formed. The basic rules of accounting and finance would still apply, except primarily at the project level instead of at the corporate level. Summary The valuation of projects is central to an organization’s capital budgeting and risk management process. Projects can be something as basic as a new product or product feature or something as complex as a completely new, fully funded joint venture between multiple entities. The project team, defined by the project itself, directly impacts the organizational structure, communication, and resource allocation. Two common methods for valuing projects include the net present value method and the internal rate of return method. The overall value of a project is distilled down to and established by the internal cash flows and the initial cash outlay required to begin the project. Project valuation has become a central reality of organizational design, and firms that excel at choosing the correct projects while effectively managing and implementing them become market leaders. Q: The nature of project and the project valuation directly impacts which of the following? A: decision making A: organizational structure

A: resource allocation X resource misallocation X decision avoidance X organizational failure X lack of communication Q: The team at Apex believes that it has chosen the right project by pursuing the coffee packaging idea because the valuation shows that the ____. A: yield of the project is greater than the hurdle rate A: yield of the project is above the weighted average cost of capital (WACC) A: internal rate of return (IRR) is above the hurdle rate X internal rate of return (IRR) is lower than the weighted average cost of capital (WACC) X yield of the project is less than the hurdle rate X yield of the project is below the weighted average cost of capital (WACC) X internal rate of return (IRR) is below the hurdle rate Q: Using the internal rate of return (IRR) method, a company can determine if which of the following is true? A: the yield of the project is above the weighted average cost of capital (WACC) A: the yield of the project is greater than the hurdle rate A: the IRR is above the hurdle rate X the IRR is below the hurdle rate X the IRR is lower than the weighted average cost of capital (WACC) X the yield of the project is less than the hurdle rate X the yield of the project is below the weighted average cost of capital (WACC) Q: Which of the following is a method of project valuation? A: Internal rate of return A: IRR

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X net future value X NPR X IRP X external rate of return Q: How is the net present value (NPV) method used to determine if a project should be done? A: The sum of cash flow for a project is compared to other projects A: the total cash flow for a project is compared to other projects A: the project from the project is considered X the sum of cash flow for a project is compared to competitors X the partial cash flow for a project is compared to other projects X the sum of the cash flows must not meet company expectations X the profit from the project is ignored Q: How is the structure of a corporation affected by the modern project valuation approach? A: it has shifted from a production structure to one focused on project dynamics A: The structure is adaptable A: it is fluid X the structure is inflexible X it is static X formal departments are more of a focus, and special skills are not utilized in all projects X it has shifted from a project structure to one that is focused on production dynamics Q: Although internal rate of return (IRR) and net present value (NPV) are numeric methods and appear very absolute, a number of other factors in their determination can influence the outcome, such as ___. A: project manager effectiveness A: accuracy of time estimates X consumer demand X what competitors are doing

X industry trends X banks Q: Project valuation is important because it allows a firm to ____. A: rank a list of projects X rank a list of products X make inefficient decisions X compare competitors X ignore the best way to allocate resources Q: Examples of cash flows that would be included in Apex’s calculation of the net present value (NPV) for the coffee packaging project include which of the following? A: taxes A: initial equipment investment X bonuses to employees in other departments X competitor’s returns X investment in coffee stock X industry investment trends Q: Projects can take many forms with the new valuation approaches. Which of the following represents a possible project? A: a new subsidiary X a nonoperational subsidiary X corporate strategic failure X an old product line X a market plan proposal Q: If the project planners at Apex are incorrect about the sales projections and should be using a figure of $15 million per year, what will this do to the project’s net present value (NPV)? (sales projections were previously $27 million per year for five years)

A: this will decrease the NPV A: The NPV will be reduced X there will be an increase in the NPV X the NPV will increase X the net present value will be raised X this will increase the chance the project will be accepted Q: When you and Lee get together to consider the projects in different industries related to different companies, what is a comment that you might make or question that you might ask? A: What is your firm’s hurdle rate? A: Have you ranked these opportunities by NPV? X what is the WACD for your company at this time? X should you calculate the IPR for each idea? X what are your firm’s major hurdles? X have you ranked these opportunities by NVI? Q: Which of the following is one of the steps used in both internal rate of return (IRR) and net present value (NPV) analysis? A: sales projection A: calculating tax liability X exploring who is in charge of which project X copying data from the last project X examining what competitors are doing Q: When calculating the net present value (NPV) for Apex, the team forgets to discount the value of the sales figures. What should they do? A: revise the sales cash flow by converting it to present value X make the figures inaccurate by discounting them X increase the sales cash flow by converting it to present value X adjust projections by using a future value factor

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