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Value Maximization Decisions

Using the data in the attached income statement, explain the three value maximization decisions. After taking a closer look at the numbers and doing the financial analysis, you begin to think more strategically, and in a broader context, you anticipate what the CFO would ask or what the head of Strategic Planning might want to know. You think about some of the key issues.

The Project:
An acquisition of a new production plant that the company will lease for 5 years at US$1,500,000 per year will cost the firm US$4,000,000 in capital (straight-line depreciation, 5 year life) in year 0; it will cost the firm an additional US$150,000 per year after the new production plant is brought online for other expenses; and it will generate an incremental revenue of US$3,500,000 per year. Use a 40% tax rate, a 10% cost of capital, and a 12% re-investment rate. Assume the company will use cash flow to finance the project.

Does this project maximize firm value?
What will be the impact to the stock price?
How does this capital project fit with the strategic direction of the firm?

In light of this, you decide to email the CFO and VP of Strategic Planning in anticipation of their questions.


Solution Preview

Attached is the file with the answers to the questions.

As we can see from the computations and final numbers in the attached Excel sheet, the company would definitely maximize its value by making this investment. The NPV of the project is really high and that strongly suggest that the company takes on it.

NPV gives us a good way to judge an important parameter, the price-to-earnings or P/E ratio. If NPV represents the value to the future cash flows, then it also represents the ideal fair price one would pay for that cash stream, i.e. that would help us ...

Solution Summary

This response explains the concept of value maximization decisions. Based on the following information, it will determine the the impact of a new project on the firm's value, stock price, and strategic direction.