Cash flow company value

IRR is the rate of return (interest rate, discount rate) at which the future cash flows (positive plus negative) would equal the initial cash outlay (a negative cash flow). The value of the IRR relative to the company standards for internal rate of return indicates the desirability of an investment ... 

Discounted-cash-flow rate of return (DCFRR) has the advantage of being unique and readily understood. However, when used alone, it gives no indication of the scale of the operation. The (NPV) indicates the monetary return, but unlike that of the (DCFRR) its value depends on the base year chosen for the calculation. Additional information is needed before its significance can be appreciated. However, when a company is considering investment in a portfoho of projects, individual (NPV)s have the advantage of being additive. This is not true of (DCFRR)s. 

For many years, companies and countries have lived with the problem of inflation, or the faUing value of money. Costs—in particular, labor costs—tend to rise each year. Failure to account for this trend in predicting future cash flows can lead to serious errors and misleading profitabihty estimates. 

The same questions may then be asked for different values of the probabilities p and po. The answers to these questions can give an indication of the importance to the company of P at various levels of risk and are used to plot the utility curve in Fig. 9-25. Positive values are the amounts of money that the company would accept in order to forgo participation. Negative values are the amounts the company woiild pay in order to avoid participation. Only when the utihty value and the expected value (i.e., the straight line in Fig. 9-25) are the same can net present value (NPV) and discounted-cash-flow rate of return (DCFRR) be justified as investment criteria. 

The chemical and petrochemical industries are highly capital intensive and this has two important implications for the plant designer. Before the expenditure for any plant is approved, a discounted cash flow (DCF) return on capital invested is projected (Section 9.1). The capital cost of the plant is a key factor in deciding whether the DCF return is above or below the cut-off value used by a company to judge the viability of projects. Thus, there is always strong pressure on the materials engineer not to overspecify the materials of construction. 

Once values have been assigned for the costs and benefits of each proposed risk-reduction modification, a variety of economic evaluation techniques may be used to choose the most attractive option. These techniques include net present value, discounted cash flow rate of return and cost-benefit ratio analyses. Most companies have a preferred method for evaluating project economics, which can be used with little or no modification. Chapter 8 of... 

Pi is the cash flow for the year i, and r is the relevant discount rate, which can be thought of either as the interest of borrowing money to start the company, or as the return from an alternate opportunity for a safe investment. This equation considers that 1 next year is worth only 1/(1 + r) dollars this year. The value of the NPV is the sum of all the cash flows for the n year, discounted by the power of compound interest. We give here the values of NPV for a number of values of r ... 

The chapter considered the engineer s fear of financials and attempted to overcome it with a straightforward discussion of cash flow, income, and balance statements. The mathematics of these statements is simple arithmetic, but the confusion seems to come from not understanding a few key terms. The chapter also considered the utility of ratio analysis—what engineers might call dimensional analysis for companies—breakeven analysis, and the basics of the time value of money. Although a full discussion was beyond the scope of this chapter, the discussion served up the basics and may also serve to introduce more careful treatments in other courses or texts. 

The principle of the NPV method is to forecast over time all cash flows associated with an investment. Each period s net cash flows are then discounted to the present.29 As discount rate usually the company s cost of capital is used because in this case a positive NPV indicates that the investment increases the company s value (cf. Rappaport 1998, p. 37 see Appendix 1 for a detailed discussion of how to derive the appropriate discount rate). The calculation of the NPV is based on the following formula ... 

As pointed out in Chapter 3.3.2 the company s cost of capital should be used to discount cash flows to their present value. As a company encounters different costs for equity and debt, the respective costs have to be identified as a prerequisite for calculating the cost of capital. 

Sources of finance for company acquisitions as mentioned above can be from reserves or maybe taken a senior or subordinated debt. Alternatively a bond may be issued with various characteristics offering an annuity, a balloon payment or a combination of the two. A variety of convertible structures have been utilized for this purpose as asset sales and the use of the target s balance sheet. There has also been a place for royalty transactions where the future-value of product cash flows are securitized to provide capital in the near term to achieve a company acquisition. 

In actual fact, however, shareholder value orientation is essentially about management decisions that create fundamental value. Fundamental value, defined as the sum of expected discounted cash flows available to shareholders, is by that definition a long-term concept. In theory, a company could pursue SHV without even caring about its share price (Fig. 2.1). 

To illustrate the method for determining net present worth, consider the example presented in Table 1 for the case where the value of capital to the company is at an interest rate of 15 percent. Under these conditions, the present value of the cash flows is 127,000 and the initial investment is 110,000. Thus, the net present worth of the project is... 

Check the values given for the discounted-cash-flow rate of return and net present worth. If the company requires a minimum rate of return of 10 percent, which system should be chosen ... 

The critical element of the strategy for accounting for inflation in design estimates is to present the results in the form of present worth (present value, profitability index, discounted cash flow) with all future dollars discounted to the value of the present dollar at zero time. The discount factor must include both the interest required by the company as minimum return and the estimated interest rate of inflation. If profits on which income taxes are charged are involved, then the present worth based on the after-tax situation should be used. 

An investment of 1,000,000 will give annual returns as shown in the following over a life of five years. Assume straight-line depreciation, negligible salvage value, and 34 percent income taxes. What is the discounted-cash-flow rate of return on the investment (Profitability Index) before and after taxes with (a) No inflation and annual returns of 300,000 each year (i.e., cash flow to the company of 300,000) before taxes ... 

Neglect interest during construction period and value-of-land effects. Note Rate of return calculations for your company must be based on discounted-cash-flow procedures to account for the time value of money. 

The fundamental value of a company, on the other hand, is the net present value of the expected future cash flows, discounted by the cost of capital (DCF). This only alters for the better or the worse if fundamental changes occur, for example if prices change, new technologies are introduced or the company achieves a breakthrough into new markets. 

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