Multicriteria cash-flow modeling and project value-multiples for two-stage project valuation (original) (raw)
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Journal of Applied Business Research (JABR), 2011
Corporate financial objective of stockholder wealth maximization and use of discounted cash flow methods for evaluation of capital projects are two of the well-accepted tenets of financial management. Present project evaluation methods, including the Net Present Value (NPV) technique, do not fully meet the stockholder wealth maximization criteria. This paper attempts to scrutinize the relevance of the NPV method in achieving the wealth maximization objective and suggests an alternative value addition measure, named Net Value Added (NVA). In the NPV method, all cash flows pertaining to a project are lumped together and discounted with one single rate, the weighted average cost of capital. The NVA method advocates that a project's residual (net of its debt servicing) cash flows that belong to stockholders should be classified on the basis of their end-use, viz., equity servicing, capital maintenance, and value creating surplus cash flows. As the risks associated with each of these three stockholders' cash flows are not the same, they are separately discounted at appropriate rate depending upon the associated risk. Power of time (n) is assigned only to real risk-free rate of return and inflation premium to discount equity servicing and capital maintenance cash flows that are subject to exponential growth over time but not to the risk premium.
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La collection "Cahiers du CEG" est un recueil de présentations de travaux réalisés au Centre Économie et Gestion de l'École du Pétrole et des Moteurs, Institut Français du Pétrole, travaux de recherche ou notes de synthèse. Elle a été mise en place pour permettre la diffusion de ces travaux, parfois sous une forme encore provisoire, afin de susciter des échanges de points de vue sur les sujets abordés. Les opinions émises dans les textes publiés dans cette collection doivent être considérées comme propres à leurs auteurs et ne reflètent pas nécessairement le point de vue de l'École du Pétrole et des Moteurs ou de l'IFP.
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Risk-Sensitive Value Measure Method for Projects Evaluation
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In this paper we study the evaluation problems for random cash flows. We first consider the evaluation of random variables, which are supposed to present the random present values (RPV) of cash flows, and investigate what the suitable evaluation functional of RPV is. We see that the concave monetary value measure (or concave monetary utility function) is the most suitable candidate for this end. Next we extend the value measure to a dynamic value measure. Then we see that the idea of time-consistency is very important, and that the dynamic entropic value measure is the best one. We can see that this dynamic value measure is related to the risk sensitive control. And finally we conclude that the risk sensitive value measure method, which is a combination of the ideas such that monetary utility function, indifference price, real option approach, time-consistency and risk sensitive control, should be the most powerful method for the project evaluation. We also explain how to apply our results to practical problems.
SSRN Electronic Journal, 2003
The real option valuation method is often presented as an alternative to the conventional discounted cash flow (DCF) approach because it is able to recognize additional project value due to the presence of management flexibility. However, these two valuation methods can be separated on a more fundamental level by their differences in risk discounting. Real option valuation applies the risk-adjustment to the source of uncertainty in the cash flow while the DCF method adjusts for risk at the aggregate level of net cash flow. This seemingly small difference is the reason why the real option method is able to differentiate between projects according to each project's unique risk characteristics while the conventional DCF approach cannot.
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The financial analysis of a project helps determine the financial viability and sustainability of the project. Since the integrated project analysis begins with the financial analysis and then the economic analysis, the concepts and data ought to be organized in a consequential and consistent manner. The comparison of either financial or economic benefits with their corresponding costs requires that all relevant data should be organized into a project profile covering the duration of the project's life. While a project profile is given by cash flows in the financial appraisal, the project's profile in the economic appraisal provides a flow of net economic benefits generated by the investment. This chapter explains how cash flow profiles of a project are developed and constructed in a consistent fashion. It also discusses how investment project can be evaluated from different points of view.
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