The
Net Present Value (NPV) : a dynamic approach
of the value Creation for Shareholders
Why
is NPV so important?
Stockholders want to make their
shares as valuable as possible.
Let's suppose that total market value (Equity
+ Debt) of the firm is 10 million €. That
includes 500.000€ cash we can invest in
project X. The value of the other assets of
the firm must therefore be 9.5 million €.
We have to decide whether it is better to keep
the 500.000€ cash and reject project X
or to spend the cash and accept project X.
|
|
Reject project X |
Accept project X |
Cash |
|
|
Other assets |
|
|
|
Project X |
|
Present value of project X
|
Total of Asset |
|
9.500.000 + PV of project X
|
The project X is worthwhile if
its present value (PV) is greater than 500.000
€ - that is, if NPV is positive. In
this case, you create value for shareholders.
Example : we invest the cash in a project
Capital
expenditure
: 500.000 €
FCF forecasted :
| |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
| FCF |
200.000 € |
250.000 € |
280.000 € |
230.000 € |
Discounted rate (WACC)
: 12 % (minimum return to satisfy debtholders
and shareholders)
NPV = - 500.000
+ 200.000.(1,12)-1 + 250.000.(1,12)-2 + 280.000.(1,12)-3
+ 230.000.(1,12)-4 = 223.000 €
|
Present value
of project X |
723.000
€ |
-
Capital expenditure |
500.000
€ |
NPV |
223.000
€ |
| |
Reject
project X |
Accept
project X |
Cash |
500.000 |
0 |
Other assets |
9.500.000 |
9.500.000 |
| PV
of Project X |
0 |
723.000 |
Total of
Asset |
10.000.000 |
10.223.000 |
IRR
(Internal Rate of Return)
= 31,11 %
500'000 = 200'000(1+IRR)-1 + 250'000(1+IRR)-2 + 280'000(1+IRR)-3 + 230'000(1+IRR)-4
We invest in this project
because :
- the NPV is positive
(+ 223.000 €)
- The IRR (31.11%) is
higher than the WACC (12 %)
- The Shareholders will
be happy because we create VALUE for them.
Calculation of the FCF (*)
| Operating
profit (EBIT) |
| - Taxes |
+ Depreciation |
ATCF |
- Capex |
|
Free
Cash Flow |
"EBIT, earnings before interest
and taxes, is the income earned by the company
without regard to how it is financed ; so EBIT
(1 - Tax rate) is income after tax, excluding
any effects of debt financing. Adding depreciation
and any other significant noncash items yields
the standard ATCF (After Tax Cash Flow). If
management were prepared to run the company
into the ground, it could distribute this cash
flow in the form of dividends and interest payments,
and that would be the end of it. But in most
companies, management retains some of this cash
flow in the business to make new investments
and to grow. Therefore, only conventional ATFC
less investment is available for distribution.
(Investment is interpreted broadly here to mean
all capital expenditures plus any increase in
net working capital)".
Value Creation in Hospitality Industry
Sources :
Principles of Corporate Finance,
8th edition, Richard A. Brealey & Stewart
C. Myers, McGraw-Hill
Corporate
Finance Course, Bernard Jaquier, Professor
of Economics & Finance, Lausanne, Switzerland, 2018
(*) Analysis for Financial
Management, 4th edition, Robert C. Higgins,
Irwin, 1995
