valuing business opportunities
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Consider the role of the finance department at Strident Marks. The finance department has a couple of new hires, and the CFO has asked that you spend a short amount of time with them, catching them up on some areas that are very important to the company at this time. These also happen to be areas for which Strident Marks does not yet have any training material. Write what you feel should be included in their training manual about the components of financial systems, focusing on valuation. What role does a financial department play in valuing business opportunities and what are some of the key financial concepts that valuation work must consider?
Objective: The student should make the distinction between valuing internal opportunities (new projects) vs. valuing external opportunities (acquisitions), as these are two separate (albeit related) disciplines. The student should also demonstrate an understanding of the key concepts in valuation: cash, risk, and timing of the cash flows.
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Consider the role of the finance department at Strident Marks. The finance department has a couple of new hires, and the CFO has asked that you spend a short amount of time with them, catching them up on some areas that are very important to the company at this time. These also happen to be areas for which Strident Marks does not yet have any training material. Write what you feel should be included in their training manual about the components of financial systems, focusing on valuation. What role does a financial department play in valuing business opportunities and what are some of the key financial concepts that valuation work must consider?
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Solution:
Finance department plays a very important role in valuing business opportunities, both internal as well as external by carefully and analyzing evaluating the opportunities on the basis of various valuation concepts and principles. In other words, once the opportunities has been identified as strategically fit for the organization, it is the finance department which gives the green signal ultimately by evaluating the attractiveness of the opportunities in financial terms. A project or acquisition, which may appear lucrative at first instance and offer strategic advantage to the firm,
might be rejected due to failure in terms of financial attractiveness.
To start with, let us first understand the difference between valuing internal and external opportunities. Valuation of internal opportunities are concerned with evaluating opportunities which exist within the organization, such as investment in new machinery, expansion of current manufacturing facilities, investments in new technology or technological upgrade.
Valuing external opportunities is concerned with evaluation of financial attractiveness of opportunities outside the organization, such as acquisitions, etc.
Now, let us see some of the financial concepts and valuation models which are used in valuing both internal as well as external opportunities.
Internal Opportunities (Investment in projects):
Some of the most popular methods to evaluate internal opportunities such as investment in new projects are:
Net Present Value Method:
Using the hurdle rate as the required rate of return, the net present value of an investment is the present value of the cash inflows minus the present value of the cash outflows. A more common way of expressing this is to say that the net present value (NPV) is the present value of the benefits (PVB) minus the present value of the costs (PVC)
NPV = PVB - PVC
The hurdle rate is the minimum acceptable rate of return on a capital investment project. Mathematically, the hurdle rate is equal to the company's cost of capital plus the project's risk premium.
By using the hurdle rate as the discount rate, we are conducting a test to see if the project is expected to earn our minimum desired rate of return.
We will accept all those investment in projects which result in a positive Net ...
Education
- BCom, SGTB Khalsa College, University of Delhi
- MBA, Rochester Institute of Technology
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