Analysing Strategic Projects and Shareholder Value Creation

The need for organisation to create and sustain value for shareholders:

• Shareholders have claims on the firm based on "ownership"
• Arguments for:
• Shareholders provide the capital for the organisation --> need pay attention to return on investment
• Maximising SHV ic compatible with interests of all stakeholders, if the company successfully increase  SHV, thus all stakeholders will also benefits.
• Arguments against:
• Other stakeholders also provide the capital for the firm an need pay more attention as they argue more about human capital and return on debt investment from debt holders.
• Shareholders are residual claimants after the company fulfil the needs of debt holders.

Traditional measurement for SHV: Dividend Payout Ratio, capital appreciation (increase of share price). Example: EPS, ROI, RONA, ROE.

Stern Stewart's Economic Value Added (EVA) --> the spread between the return on capital and the cost of capital multiplied by the "economic book value" of the capital employed to produce that return.

• EVA = NOPAT - (WACC X Capital Employed)
• Note: 
• EVA is dollar figure, not a rate of return (%). 
• Relates to profit to the amount of resources required to achieve that profit.
• Emphasis after-tax operating profit and actual cost of capital, and eliminates distortions due to financing (not operating) decisions. 
• Strategies to increase EVA:
• Improve operating profits without tying up further capital.
• Draw down more capital, so long as the additional profits management earn by investing the funds in its business more than covers the cost of the additional capital.
• Free up capital and pay down the line of credit, so long as any earnings lost are more than offset by a saving on the capital charge.
• EVA Strength:
• Adjusts for some non-cash flow items (eg amortisation)
• WACC; reflect risk, time value of money and opportunity cost of equity.
• Highly correlated with share prices.
• EVA Weaknesses:
• Complexity (via adjustment)
• Short-term focus, single period measure.
• Comparison across firms may be difficult due to many possible adjustments.

Economic Value of a Project: NPV and IRR.

• Shareholder (and project) value is driven by:
• sales growth rate --> expected Net Cash Flow (NCF) from project
• operating profit margin --> expected Net Cash Flow (NCF) from project
• cash tax rate --> expected Net Cash Flow (NCF) from project
• fixed and working capital requirement --> initial investment + other investment during project life.
• Planning period --> expected project life
• Cost of capital --> hurdle rate/discount rate.
• Strategic issues in project appraisal --> may not profitable in short-term financial perspective, but in long-term and strategic decision, may be different. There are some important factors affecting competitiveness, which often overlooked or excluded in the quantification of project cash flow, for example:
• higher market penetration due to shorter lead times.
• increased product quality and consistency of that quality.
• ability to produce small batches economically.
• flexibility and reduce uncertainty.