Capital Budgeting Valuation E-Book

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Robert W. Kolb Series
• Sprache: Englisch

Seitenzahl: 1072

Veröffentlichungsjahr: 2011

Beschreibung

An essential guide to valuation techniques and financial analysis With the collapse of the economy and financial systems, many institutions are reevaluating what they are willing to spend money on. Project valuation is key to both cost effectiveness measures and shareholder value. The purpose of this book is to provide a comprehensive examination of critical capital budgeting topics. Coverage extends from discussing basic concepts, principles, and techniques to their application to increasingly complex, real-world situations. Throughout, the book emphasizes how financially sound capital budgeting facilitates the process of value creation and discusses why various theories make sense and how firms can use them to solve problems and create wealth. * Offers a strategic focus on the application of various techniques and approaches related to a firm's overall strategy * Provides coverage of international topics based on the premise that managers should view business from a global perspective * Emphasizes the importance of using real options Comprised of contributed chapters from both experienced professionals and academics, Capital Budgeting Valuation offers a variety of perspectives and a rich interplay of ideas related to this important financial discipline.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Acknowledgments

Chapter 1: Capital Budgeting: An Overview

INTRODUCTION

STRUCTURE OF THE BOOK

SUMMARY AND CONCLUSIONS

REFERENCES

ABOUT THE AUTHORS

Part I: Foundation and Key Concepts

Chapter 2: Corporate Strategy and Investment Decisions

INTRODUCTION

THE IMPORTANCE OF STRATEGY FOR INVESTMENT DECISIONS

KEY CONCEPTS AND IDEAS IN STRATEGY

CORPORATE STRATEGY, INVESTMENT, AND PERFORMANCE: SOME EVIDENCE

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHOR

Chapter 3: Corporate Governance and Investment Decisions

INTRODUCTION

THE CAUSES OF INVESTMENT DISTORTIONS

IMPACT OF CORPORATE GOVERNANCE ON INVESTMENT DISTORTIONS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Part II: Capital Investment Choice

Chapter 4: Measuring Investment Value

INTRODUCTION

NPV AND IRR

CASH FLOWS

TAX SAVINGS, DISCOUNT RATES, AND THE FUNDING MIX OF CAPITAL

DYNAMIC NPV

ECONOMIC VALUE ADDED

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 5: Alternative Methods of Evaluating Capital Investments

INTRODUCTION

AN AGENCY PROBLEM BETWEEN MANAGERS AND SHAREHOLDERS

THE PAYBACK PERIOD AND ITS VARIATIONS

IRR: SCALE AND TIMING EFFECTS

NPV AND IRR: MUTUALLY EXCLUSIVE PROJECTS

REINVESTMENT RATES AND MULTIPLE IRRS

PROFITABILITY INDEX

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 6: Capital Rationing for Capital Budgeting

INTRODUCTION

DEFINITION OF CAPITAL RATIONING FOR CAPITAL BUDGETING

HOW DOES CAPITAL RATIONING WORK TO IMPROVE CAPITAL BUDGETING?

CONDITIONS FOR SUCCESSFUL CAPITAL RATIONING

NEGATIVE SIDE EFFECTS OF COMPETITIVE CAPITAL RATIONING

RESEARCH RESULTS ON THE EFFECTS OF COMPETITION ON THE RELIABILITY OF MANAGERIAL REPORTING

HONESTY IN MANAGEMENT REPORTING AND BUDGET PROPOSALS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHOR

Chapter 7: Analyzing Foreign Investments

INTRODUCTION

FINANCIAL VALUATION PROCESS

FINANCIAL MODELING BASICS

FINANCIAL MODELING COMPLICATIONS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 8: Postcompletion Auditing of Capital Investments*

INTRODUCTION

PCA ADOPTION RATES

MANAGERIAL USES OF PCA

PROBLEMS ASSOCIATED WITH PCA

EXPLAINING ADOPTION AND NONADOPTION OF PCA

DESIGN OF A PCA SYSTEM

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHOR

Chapter 9: Capital Budgeting Techniques in Practice: U.S. Survey Evidence

INTRODUCTION

CAPITAL BUDGETING PROCESS

SURVEYS ON U.S. FIRMS

ANALYSIS OF PAST SURVEYS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Part III: Project Cash Flows and Inflation

Chapter 10: Estimating Project Cash Flows

INTRODUCTION

THEORETICAL DISCUSSION

RELEVANT CASH FLOWS

FORECAST OF NET CASH FLOWS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 11: Capital Budgeting and Inflation

INTRODUCTION

LITERATURE REVIEW

REASONS TO JUSTIFY A REAL OR CONSTANT PRICES APPROACH

IMPACTS OF INFLATION ON THE FINANCIALS: AN EXAMPLE

ACCOUNTS RECEIVABLE

ACCOUNTS PAYABLE

INCOME STATEMENT AND BALANCE SHEET

SUMMARY AND CONCLUSIONS

ABOUT THE AUTHORS

APPENDIX 11.1 NOMINAL RATES VERSUS REAL RATES: FISHER EQUATION

DISCUSSION QUESTIONS

REFERENCES

Part IV: Risk and Investment Choice

Chapter 12: Basic Risk Adjustment Techniques in Capital Budgeting

INTRODUCTION

DECISION-MAKING TECHNIQUES FOR RISKY CAPITAL BUDGETING PROJECTS

THE JUDGMENT APPROACH

ADJUSTING THE PAYBACK PERIOD

THE CERTAINTY EQUIVALENT METHOD

THE RISK-ADJUSTED DISCOUNT RATE METHOD

COMPARING THE CE AND RADR METHODS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 13: Capital Budgeting with Political/Country Risk

INTRODUCTION

METHODS AND TECHNIQUES OF POLITICAL/COUNTRY RISK ANALYSIS

INCORPORATING POLITICAL RISK IN THE CAPITAL BUDGETING DECISION

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 14: Risk Management in Project Finance

INTRODUCTION

PROJECT FINANCE AS A NEXUS OF CONTRACTS

RISK MANAGEMENT IN PROJECT FINANCE

CAPITAL BUDGETING IN PROJECT FINANCE

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 15: Risk Simulation Concepts and Methods

INTRODUCTION

INITIAL STATIC MODEL

INITIAL SIMULATION AND ANALYSIS

SIMULATION WITH CORRELATED INPUTS

COMPACT PRO FORMA MODELS

OTHER SIMULATION-BASED APPLICATIONS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

APPENDIX: GENERATING RANDOM NUMBERS IN EXCEL

REFERENCES

ABOUT THE AUTHORS

Part V: Real Options and Project Analysis

Chapter 16: Real Options Analysis

INTRODUCTION

A REAL OPTIONS NUMERICAL EXAMPLE

A REAL OPTIONS NUMERICAL EXAMPLE WITH MULTIPLE DECISION POINTS

THE BLACK-SCHOLES MODEL

UNDERINVESTMENT PROBLEM AND EMERGENCE OF REAL OPTIONS ANALYSIS

TYPES OF REAL OPTIONS

USE OF REAL OPTIONS ANALYSIS IN PRACTICE

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 17: Applications of Real Options Analysis

INTRODUCTION

OPTION TO DEFER OR OPTION TO WAIT

STAGED INVESTMENT OPTION

OPTION TO ALTER THE SCALE OF OPERATIONS

OPTION TO ABANDON

OPTION TO SWITCH INPUTS OR OUTPUTS

GROWTH OPTIONS

RAINBOW OPTIONS OR MULTIPLE INTERACTING OPTIONS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Part VI: Estimating the Project Cost of Capital

Chapter 18: Cost of Capital

INTRODUCTION

COST OF CAPITAL

COST OF CAPITAL WEIGHT ESTIMATION

THE WACC COMPONENT COST ESTIMATION

COMPREHENSIVE EXAMPLE OF ESTIMATING THE WACC

COST OF CAPITAL FOR A PROJECT

COST OF CAPITAL IN AN INTERNATIONAL CONTEXT

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 19: Using the Capital Asset Pricing Model and Arbitrage Pricing Theory in Capital Budgeting

INTRODUCTION

THE CAPITAL ASSET PRICING MODEL

THEORETICAL EXTENSIONS OF THE CAPM

CHALLENGES TO USING THE CAPM

BIASES IN TESTING FOR THE VALIDITY OF THE CAPM

THE ARBITRAGE PRICING THEORY

RECENT DEVELOPMENTS: DOES INFORMATION ASYMMETRY MATTER TO THE COST OF EQUITY?

USING THE CAPM AND THE APT IN PRACTICE

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 20: Financing Mix and Project Valuation

INTRODUCTION

CONVENTIONAL PROJECT VALUATION METHODS

CONSISTENCY OF METHODS UNDER THE TARGET-DEBT-RATIO ASSUMPTION

THE ADJUSTED PRESENT VALUE APPROACH

PITFALLS WHEN APPLYING PROJECT-VALUATION METHODS

ADJUSTING FOR CAPITALIZED INTEREST COSTS

VALUATION OF THE MULTINATIONAL FIRM'S PROJECTS: THE GENERALIZED ATWACC METHOD

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Part VII: Special Topics

Chapter 21: Capital Budgeting for Government Entities

INTRODUCTION

AN OVERVIEW OF GOVERNMENT CAPITAL BUDGETING PRACTICES

CURRENT GOVERNMENT CAPITAL BUDGETING PRACTICES

GOVERNMENT CAPITAL PROJECT APPRAISAL METHODS

LESSONS LEARNED IN IMPROVING CAPITAL BUDGETING PRACTICES IN GOVERNMENT ENTITIES

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHOR

Chapter 22: Decision Making Using Behavioral Finance for Capital Budgeting

INTRODUCTION

COGNITIVE DIMENSION

ORGANIZATIONAL DIMENSION

INSTITUTIONAL DIMENSION

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHORS

Chapter 23: Merger and Acquisition Pricing: The Valuation of Synergy

INTRODUCTION

TYPES OF MERGERS AND SYNERGY

THE SUCCESS OF MERGERS AND THE VALUATION OF SYNERGY PREMIUMS

DIFFERENT ELEMENTS—DIFFERENT PRICING

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHOR

Chapter 24: Multicriteria Analysis for Capital Budgeting

INTRODUCTION

THE CONCEPT OF MCA

ELEMENTS OF MCA AND DECISION MAKING

METHODS OF MCA AND DECISION MAKING

ROBUSTNESS OF RESULTS OF MCA METHODS

APPLICATIONS OF MCA METHODS

IMPLEMENTING MCA: SOME KEY CONSIDERATIONS

SUMMARY AND CONCLUSIONS

DISCUSSION QUESTIONS

REFERENCES

ABOUT THE AUTHOR

Answers to Discussion Questions

CHAPTER 2 CORPORATE STRATEGY AND INVESTMENT DECISIONS

CHAPTER 3 CORPORATE GOVERNANCE AND INVESTMENT DECISIONS

CHAPTER 4 MEASURING INVESTMENT VALUE: FREE CASH FLOW, NET PRESENT VALUE, AND ECONOMIC VALUE ADDED

CHAPTER 5 ALTERNATIVE METHODS OF EVALUATING CAPITAL INVESTMENTS

CHAPTER 6 CAPITAL RATIONING FOR CAPITAL BUDGETING

CHAPTER 7 ANALYZING FOREIGN INVESTMENTS

CHAPTER 8 POSTCOMPLETION AUDITING OF CAPITAL INVESTMENTS

CHAPTER 9 CAPITAL BUDGETING TECHNIQUES IN PRACTICE: U.S. SURVEY EVIDENCE

CHAPTER 10 ESTIMATING PROJECT CASH FLOWS

CHAPTER 11 CAPITAL BUDGETING AND INFLATION

CHAPTER 12 BASIC RISK ANALYSIS TECHNIQUES IN CAPITAL BUDGETING

CHAPTER 13 CAPITAL BUDGETING WITH POLITICAL/COUNTRY RISK

CHAPTER 14 RISK MANAGEMENT IN PROJECT FINANCE

CHAPTER 15 RISK SIMULATION CONCEPTS AND METHODS

CHAPTER 16 REAL OPTION ANALYSIS: INTRODUCTION

CHAPTER 17 APPLICATIONS OF REAL OPTIONS ANALYSIS

CHAPTER 18 COST OF CAPITAL: AN INTRODUCTION

CHAPTER 19 USING THE CAPITAL ASSET PRICING MODEL AND ARBITRAGE PRICING THEORY IN CAPITAL BUDGETING

CHAPTER 20 FINANCING MIX AND PROJECT VALUATION: ALTERNATIVE METHODS AND POSSIBLE ADJUSTMENTS

CHAPTER 21 CAPITAL BUDGETING FOR GOVERNMENT ENTITIES

CHAPTER 22 DECISION MAKING USING BEHAVIORAL FINANCE FOR CAPITAL BUDGETING

CHAPTER 23 MERGERS AND ACQUISITIONS PRICING: THE VALUATION OF SYNERGY

CHAPTER 24 MULTICRITERIA ANALYSIS FOR CAPITAL BUDGETING

Index

The Robert W. Kolb Series in Finance provides a comprehensive view of the field of finance in all of its variety and complexity. The series is projected to include approximately 65 volumes covering all major topics and specializations in finance, ranging from investments, to corporate finance, to financial institutions. Each volume in the Kolb Series in Finance consists of new articles especially written for the volume.

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Copyright © 2011 by John Wiley & Sons. All rights reserved.

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Library of Congress Cataloging-in-Publication Data:

Baker, H. Kent (Harold Kent), 1944- Capital budgeting valuation : financial analysis for today's investment projects / H. Kent Baker and Philip English. p. cm. – (The Robert W. Kolb series in finance) Includes index. ISBN 978-0-470-56950-4 (cloth); ISBN 978-1-118-04456-8 (ebk); ISBN 978-1-118-04454-4 (ebk); ISBN 978-1-118-04455-1 (ebk) 1. Capital budget. 2. Capital investments. 3. Value added. I. English, Philip. II. Title. HG4028.C4B285 2011 658.15′4–dc22 2010049527

Acknowledgments

Capital Budgeting Valuation—Financial Analysis for Today's Investment Projects reflects the involvement both directly and indirectly of many people. A distinguished group of academics and practitioners contributed their substantial talents to writing highly informative and useful chapters. Much of their work, however, relies upon numerous individuals who have contributed to the field of capital budgeting during the past five decades, many of whom are referenced specifically in each chapter. Special thanks go to Meghan Nesmith from American University, who edited the chapters and provided many helpful suggestions. The publishing team at John Wiley & Sons, Inc., including Evan Burton, Claire Wesley, Emilie Herman and many others, did a first-class job in bringing the book to final production. We also thank Bob Kolb for including this book in the Robert W. Kolb Series in Finance and the Kogod School of Business Administration at American University for providing support. Finally, we thank Linda Baker who provided not only encouragement but also reviewed parts of the manuscript.

Part I

Foundation and Key Concepts

Chapter 1

Capital Budgeting: An Overview

H. KENT BAKER

University Professor of Finance and Kogod Research Professor, Kogod School of Business, American University

PHILIP ENGLISH

Assistant Professor of Finance, Kogod School of Business, American University

INTRODUCTION

Capital budgeting refers to the process that managers use to make decisions about whether long-term investments or capital expenditures are worth pursuing by their organizations. In other words, capital budgeting is the process of planning, analyzing, selecting, and managing capital investments. The basic notion is that managers use the capital, usually long-term funds, raised by their firms to invest in assets (also called capital goods) that will enable the firm to generate cash flows for at least several years into the future. Typical investments include replacements of existing assets and expansion of existing or new product lines. Capital budgeting is one of the most challenging tasks facing management because it concerns the investment decision, which deals with allocating funds over time in order to achieve a firm's objectives. For most companies, the investment decision has a greater impact on value than does the financing decision, which deals with acquiring needed funds. However, both investment and financing decisions are intertwined and at the heart of financial management.

Capital budgeting has a long-term focus that provides a link to an organization's strategic plan, which specifies how an organization expects to accomplish long-term strategic goals. Many capital investments require a substantial commitment of a firm's resources that directly affect firm performance, competitive position, and future direction. Because capital investments often commit a large amount of funds for lengthy periods, they are not only difficult or costly to reverse but also difficult to convert to more liquid assets (Migliore and McCracken, 2001). Also, errors in capital budgeting can affect the firm over a long horizon.

Capital Budgeting Process

The capital budgeting process is a system of interrelated steps for generating long-term investment proposals; reviewing, analyzing, and selecting them; and implementing and following up on those selected. This process is dynamic because changing factors in an organization's environment may influence the attractiveness of current or proposed projects. Although no universal consensus exists on the process, Baker and Powell (2005, p. 196) view capital budgeting as a six-stage process:

1.Identify project proposals. Develop and provide preliminary screening of project proposals.

2.Estimate project cash flows. Identify and estimate the incremental, after-tax cash flows for a proposed project.

3.Evaluate projects. Determine the financial viability of a project by evaluating the project's incremental after-tax cash flows.

4.Select projects. Choose the projects that best meet the selection criteria.

5.Implement projects. Determine the order of implementation, initiate, and track the selected projects.

6.Perform a postcompletion audit. Periodically compare the actual cash flows for the project to the prior estimates in the capital budgeting proposal.

All stages of the capital budgeting process are important. The failure to properly complete any stage of the capital budgeting process could have detrimental results. The process starts with the identification of investment opportunities and the preliminary screening of project proposals. Without having potentially viable projects that meet the firm's strategic concerns, the remainder of the capital budgeting process would be meaningless.

Arguably, the most challenging phase of this process is estimating project cash flows because no later stage in the process can fully overcome the inevitable forecasting errors resulting from managers dealing with an uncertain future. Miller (2000, p. 128) notes that “In the real world, virtually all numbers are estimates. The problem with estimates, of course, is that they are frequently wrong.”

Despite the importance of estimating project cash flows, the financial literature tends to emphasize the evaluation and selection stages. Improper valuation can lead to incorrect decisions despite the identification of potentially viable projects and accurate estimation of their cash flows. Although many capital budgeting techniques are available for evaluating capital budgeting projects, the best methods typically recognize the amount, the time value, and the riskiness of a project's cash flows.