scholarly journals Role of debt-to-equity ratio in project investment valuation, assessing risk and return in capital markets

2021 ◽  
Vol 7 (1) ◽  
Author(s):  
Vasishta Bhargava Nukala ◽  
S. S. Prasada Rao
Keyword(s):  
Stock Price ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Cash Flows ◽  
Equity Capital ◽  
Present Value ◽  
Gross Margin ◽  
Potential Growth ◽  
Equity Risk ◽  
Equity Ratio

AbstractIn this paper, a case study was performed with an aim to analyze the asset returns for two different companies and the risk and returns from capital projects using standard capital asset pricing method. To demonstrate how the present values of future cash flows are influenced by discount rates when the debt-to-equity capital structure ratio is varied between 0 and 2.5 debt-to-equity. The breakeven sensitivity was also conducted in relation to different gross margin ratios of company. It was found that high value of debt-to-equity ratio yielded a flatter net present value with increase in gross margins. Capital appraisal techniques were applied to illustrate the project returns and annual cash flows and its relationship with change in cost of capital. Analysis showed that when average cost of capital is increased beyond threshold value, the net present value from the firm’s project investments reduced significantly. A covariance analysis was performed to determine individual returns from two stocks traded in BSE Sensex and S&P 500 indices using the beta values. Comparing the individual and total returns of two stocks revealed that returns not only increased with increasing beta values–but also varied with earnings potential, growth rate of firm, dividend payout ratios and trading stock price. The standard deviation on portfolio of two stocks has been computed for varying asset weight ratios. It has been found that positive correlation between two stocks increased equity risk when weight ratios are not balanced in portfolio, while a negative correlation reduced equity risk.

Usec Inc.

2017 ◽  
pp. 1-11
Author(s):  
Kenneth M. Eades ◽  
Ben Mackovjak ◽  
Lucas Doe
Keyword(s):  
Stock Price ◽  
Capital Investment ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Investment Decision ◽  
Weighted Average ◽  
Cash Flows ◽  
Primary Objective ◽  
Discounted Cash Flow ◽  
Important Input

This case is designed to present students with the challenges of formulating a discounted-cash-flow (DCF) analysis for a strategically important capital-investment decision. Analytically, the problem is representative of most corporate investment decisions, but it is particularly interesting because of the massive size of the American Centrifuge Project and the potential of the project to significantly affect the stock price. Students must determine the relevant cash flows, paying close attention to the treatment of input costs, selling prices, timing of investment outlays, depreciation, and inflation. An important input is the appropriate cost of uranium, which some students argue should be included at book value, while others argue that market value should be used. Although the primary objective of the case is to focus on the estimation of cash flows, students are provided with a straightforward set of inputs to estimate USEC's weighted average cost of capital. The case is designed for students who are learning, or need a refresher on, DCF analysis. Because of the basic issues covered, the case works well with undergraduate, MBA, and executive-education audiences. The case also affords the opportunity to explore a variety of issues related to capital-investment analysis, including relevant costs, incremental analysis, cost of capital, and sensitivity analysis. The case is an excellent example of the value of a firm as the value of assets in place plus the net present value of future growth opportunities.

A New Approach to Capital Budgeting in Closely-Held Firms and Small Firms

1981 ◽  
Vol 5 (4) ◽  
pp. 30-35 ◽  
Author(s):  
Thomas H. McInish ◽  
Ronald J. Kudla
Keyword(s):  
Small Firms ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Weighted Average ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Separation Principle ◽  
Discount Rates ◽  
Present Value ◽  
Investor Returns

The traditional application of the net present value method in capital budgeting involves the use of market derived discount rates such as the cost of capital. Justification of these discount rates stems from the separation principle that states that investment decisions can be made independent of shareholders' tastes and preferences. The purpose of this paper is to show that the separation principle does not hold for closely-held firms and small firms, and, accordingly, market-derived discount rates are inappropriate. Two capital budgeting techniques which are appropriate for these firms are presented. Accept/reject decisions for capital budgeting projects are often made using a technique known as “net present value” (NPV).1 Using the NPV method, acceptable projects are those for which the project's cost is less than the present value of the project's cash flows discounted at the firm's cost of capital; in other words, acceptable projects have a positive NPV. The firm's cost of capital is usually taken to be the weighted average of the firm's cost of equity and debt as measured by investor returns in the capital markets. Justification for use of a discount rate, determined by reference to market-wide investor returns, is based on “the separation principle” which asserts that corporations can make capital budgeting decisions independently of their shareholders' views.2 But because a critical assumption of the separation principle is that shares are readily marketable, it is likely that the separation principle and, hence, market-determined discount rates are inappropriate for closely-held firms and small firms.3 In this paper, we discuss two capital budgeting approaches which are applicable to firms whose shares are not readily marketable. This paper is divided into five sections. First, we discuss the traditional net present value approach to capital budgeting and, then, we indicate in detail, why it may not be suitable for use by closely-held firms and small firms. In the third and fourth sections, we explain two capital budgeting techniques which may be appropriate for use by these firms. Finally, we summarize our conclusions.

Valmont Industries, Inc.

2017 ◽  
pp. 1-20
Author(s):  
Kenneth M. Eades ◽  
Jay Caver ◽  
Jennifer Hill
Keyword(s):  
Stock Price ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Economic Value ◽  
Value Added ◽  
Economic Value Added ◽  
Present Value ◽  
Price Performance

This case serves as an introduction to the concept of economic value added (EVA). The student is placed in the position of Valmont's CFO to decide whether EVA can live up to its promise to motivate managers to act like shareholders and ultimately lead them to make value-enhancing decisions that can reverse Valmont's weak earnings and lackluster stock-price performance. The case works best if students are acquainted with the concepts of cost of capital and net present value. The teaching note that is available for registered faculty explains how to incorporate the accompanying six-minute video supplement.

scholarly journals Decision Making for Project Appraisal in Uncertain Environments: A Fuzzy-Possibilistic Approach of the Expanded NPV Method

Symmetry ◽  
2020 ◽  
Vol 13 (1) ◽  
pp. 27
Author(s):  
Konstantinos A. Chrysafis ◽  
Basil K. Papadopoulos
Keyword(s):  
Net Present Value ◽  
Fuzzy Numbers ◽  
Cost Of Capital ◽  
Weighted Average ◽  
Present Value ◽  
Major Drawback ◽  
Project Appraisal ◽  
Equity Cost ◽  
Set Up ◽  
Intelligent Methods

The major drawback of the classic approaches for project appraisal is the lack of the possibility to handle change requests during the project’s life cycle. This fact incorporates the concept of uncertainty in the estimation of this investment’s worth. To resolve this issue, the authors use fuzzy numbers, possibilistic moments of fuzzy numbers and the hybrid (fuzzy statistic) fuzzy estimators’ method in order to introduce a fuzzy possibilistic version of the expanded net present value method (FPeNPV). This approach consists of two factors: the fuzzy possibilistic NPV and the fuzzy option premium. For the estimation of the fuzzy NPV, some basic assumptions are taken into consideration: (1) the opportunity cost of capital, used as the present value interest factor calculated through the weighted average cost of capital (WACC), (2) the equity cost, determined through the possibilistic set-up of the capital asset pricing model CAPM, and (3) the inflation factor, also included in the estimation of the NPV. The fuzzy estimators’ method is used for the computation of the fuzzy option premium. An algorithm of nine major steps leads to the computation of the FPeNPV. This gives the administration the opportunity to adapt to potential changes in the company’s internal and external environments. In this way, the symmetry between the planning and execution phase of a project can be reinstated. The results validate the statement that fuzzy and intelligent methods remain valuable tools to express uncertainty in various scientific areas. Finally, an illustrative example aims at a thorough comprehension of this new approach of the expanded NPV method.

scholarly journals Reinvestment Bias When Analyzing Mutually Exclusive Assets

2011 ◽  
Vol 2 (3) ◽  
pp. 71
Author(s):  
Robert J. Sweeney
Keyword(s):  
Net Present Value ◽  
Capital Budgeting ◽  
Cash Flows ◽  
Rate Of Return ◽  
Internal Rate Of Return ◽  
Present Value ◽  
Internal Rate ◽  
Current Period ◽  
The Cost ◽  
Flows Over Time

Capital budgeting decisions generally involve the commitment of resources in the current period to secure positive cash flows over time that generate a rate of return in excess of the cost of the funds invested. The most common techniques used to perform this analysis are the Net Present Value (NPV) and the Internal Rate of Return (IRR).Conceptually, these two techniques are substitutable; i.e. the resulting decision from a NPV analysis is identical to the decision from an IRR analysis. In practice, however, the NPV and the IRR can, on occasion, produce conflicting decisions. Specifically, when analyzing mutually exclusive assets the Net Present Value can support one asset while the Internal Rate of Return supports the other. The purpose of this paper is twofold; first, to highlight structural deficiencies in the conventional application of the NPV and the IRR, and second, to demonstrate a procedure to correct for these structural errors.

VALUASI BISNIS BARU DAN OPTIMAL CAPITAL PERUSAHAAN JASA INDUSTRI (MAKLON) BAGI UMKM KERIPIK KEMASAN. (STUDI KASUS: PT KRISPINDO)

2020 ◽  
Vol 12 (2) ◽  
pp. 254-269
Author(s):  
Helena Dewi
Keyword(s):  
Cash Flow ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Free Cash Flow ◽  
Rate Of Return ◽  
Internal Rate Of Return ◽  
Going Concern ◽  
Internal Rate ◽  
New Business ◽  
Equity Ratio

The increase of MSMEs in the food and beverage industry recently experiencing significant growth, especially during the Covid-19 pandemic. According to statistical data released by the Badan Pusat Statistik (BPS) in November 2020, the food industry dominated Micro and Small businesses in 2019 for 36.23%. The increasing number of MSME businesses in this sector becomes an opportunity for the processing services industry (contract manufacturer) to help MSMEs with all limitations. This study conducted a case study on PT. Krispindo as a company engaged in processing services (contract manufacturer) in the snack sector. This research aims to assess (valuation) new business proposed by PT. Krispindo in terms of optimal use of debt and equity for the company and also investment returns that can be given to investors. In addition, this research also aims to assist the company in making decisions for the following period project, decision to continue or discontinue the business. This study used optimal Cost of Capital (WACC) and Debt-to-Equity Ratio (DER) in setting optimal business capital. To measure investment return expectations for investors, the study used the company's Net Present Value (NPV), Free Cash Flow to Firm (FCFF) and Internal Rate of Return (IRR) approaches. To find out whether or not the business is further, this study uses Terminal Value Asset (TVA) and On Going Concern Value from the business obtained when the project ending. The results prove using debt in capital has more benefit for the company and the business can continue after the projection period ends.   Keywords: New Business Valuation (NPV), Debt-to-equity ratio (DER), Average Cost of Capital (WACC), Free Cash Flow to Firm (FCFF), Internal Rate of Return (IRR), Terminal Value Asset (TVA) and On Going Concern Value

The Weitzman Argument

2012 ◽  
Author(s):  
Christian Gollier
Keyword(s):  
Discount Rate ◽  
Opportunity Cost ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Cash Flows ◽  
Simple Rule ◽  
Rate Of Return ◽  
Net Benefit ◽  
Investment Projects ◽  
Net Benefits

This chapter examines a model in which the exogeneous rate of return of capital is constant but random. Safe investment projects must be evaluated and implemented before this uncertainty can be fully revealed, i.e., before knowing the opportunity cost of capital. A simple rule of thumb in this context would be to compute the net present value (NPV) for each possible discount rate, and to implement the project if the expected NPV is positive. If the evaluator uses this approach, this is as if one would discount cash flows at a rate that is decreasing with maturity. This approach is implicitly based on the assumptions that the stakeholders are risk-neutral and transfer the net benefits of the project to an increase in immediate consumption. Opposite results prevail if one assumes that the net benefit is consumed at the maturity of the project.

scholarly journals Evaluating Financial Viability of Olive Mills Enterprise in Jordan

2014 ◽  
Vol 6 (4) ◽  
pp. 173
Author(s):  
Bassam Aldeseit
Keyword(s):  
Net Present Value ◽  
Cash Flows ◽  
Rate Of Return ◽  
Cost Ratio ◽  
Financial Viability ◽  
Internal Rate Of Return ◽  
Present Value ◽  
Benefit Cost Ratio ◽  
Olive Oil Mills ◽  
Benefit Cost

The main aim of this study was to evaluate financial viability of olive oil mills enterprise. Thirty olive mills were investigated. A questionnaire was designed to obtain information from mills owners. The information obtained was mainly related to costs and returns. Cash flows were derived from costs and returns items of the enterprise. Three main discounted measures of project worth were used; these were Net Present Value (NPV), the Internal Rate of Return (IRR), and the Benefit Cost Ratio (B/C). The results of this study revealed that olive mills could be a viable encouraging, and profitable enterprise because of its capability to generate a highly positive and acceptable NPV (837966.05 JDs). The IRR (85%) and B/C ratio (2.3) values for this enterprise were economically accepted.

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