Chapter 1

Overview of
projects and
businesses
planning and
evaluation
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 Investment definition
Investment involves making a sacrifice in the
present with the hope of deriving future benefits.

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 Characteristics of investment???

1/ the action or process of using sources for making

profit.
2/ Length: more than 1 years
3/ All investment activities include capital

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 Investments that Create Value
The objective of a firm is to create wealth by initiating and managing
investments that generate future cash flows that are worth more than
the amount invested.
Invest $100 million today in a project that generates a stream of cash
flows valued at $150 million.
Investment generates an incremental $50 million in wealth for its
shareholders.
The project has a net present value (NPV) of $50 million.1

1You will recall that NPV is equal to the difference between the value of expected future cash flows derived from an investment and the cost of
making the investment.

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 Major Investment Decisions
We will discuss how firms evaluate investments and grow and expand through:

Project valuation: firms acquire productive

capacity by assembling necessary assets.
Enterprise valuation: acquisitions of entire
businesses - acquiring the productive assets of an
existing firm
Common valuation tools and underlying principles can
be used for both types of analysis.

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 Project & Enterprise Valuation
We will discuss how firms evaluate investments and grow and expand through:

Project Valuation Enterprise Valuation

Rio Tinto joint venture
agreement with CODELCO for
copper exploration in Chile
Microsoft and HP 3-year $250
million investment into cloud
computing
Coca-Colas bottling and
distribution joint-ventures in
China
Fashion retailer Zaras (parent
company Inditex) 77 market
entries across the world
including the most recent into
India.
Kraft Foods Inc. acquisition of
Cadbury plc
Walt Disney Cos acquisitions of
Marvel and Pixar
Coca-Cola Co. and PepsiCos
respective deals to acquire
bottler operations
As of July 2010, Google has
acquired 76 companies including
Doubleclick and YouTube

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 Investments that Destroy Value

Over half of all large investment projects fail to

achieve their hoped-for results.1
Potential causes:
Managers go with their gut
Investments in risky projects
Uncertain future events
Incomplete information

1Nadim F. Matta and Ronald N. Ashkenas, 2003, Why good projects fail anyway, Harvard Business Review (September), 109114.

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 Investments that Destroy Value

DaimlerChrysler formed by the $36 billion acquisition of Chrysler by

Germany's Daimler-Benz in 1998
Net cash outflows, restructuring payments, Chrysler bleeding cash and
unlikely to become profitable under the best-case scenario until 2009
2007 Cerberus Capital Management acquisition of 80% of Chrysler for
$7.4 billion
According to one analyst, "Daimler is basically paying Cerberus to get rid
of it.
More trouble in July 2007 with the debt capital market crunch
Trouble in syndication - J.P. Morgan Chase, Bear Stearns and Morgan Stanley
asked Cerberus and DaimlerChrysler AG, to pay higher interest rates and
change the convents.

Source: Cerberus 'rescues' Daimler www.thedeal.com May-15-2007 and Debt world trauma: Tricky talks Jul-30-2007; by Lisa Gewirtz-Ward

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 The failure of a project

Colgates Kitchen Entrees in 1982

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 The failure of a project

Ponds toothpaste in 2000

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 Classification of projects

1/ Independent projects
2/ Mutually Exclusive Projects
3/ Dependent projects

1Nadim F. Matta and Ronald N. Ashkenas, 2003, Why good projects fail anyway, Harvard Business Review (September), 109114.

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 Why the project valuation
should be implemented????

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 Necessity of project valuation

Selecting a good project, preventing ineffective

projects.
Are the components of the project appropriate?
Identification of risks when the project is
implemented
Proactively control risks

1Nadim F. Matta and Ronald N. Ashkenas, 2003, Why good projects fail anyway, Harvard Business Review (September), 109114.

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 Project Valuation Issues to Consider

In any situation in which a company must value a major new investment, five
key issues arise:

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 Project Evaluation Definition

The evaluation can be very complex.

Firms develop policies and procedures that
prescribe how to evaluate new investment
opportunities.
The purpose: to ensure that projects receive a
thorough analysis and that the project selection
process is not subverted by the special interests
of one or more managers.

1Nadim F. Matta and Ronald N. Ashkenas, 2003, Why good projects fail anyway, Harvard Business Review (September), 109114.

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 Valuation: Tool for Value Creation

Managements goal is to avoid decision errors

based on flawed or incomplete analysis
Valuation provides tools for the evaluation of new
investment opportunities
From capital budgeting to mergers &
acquisitions, valuation is more than discounting
cash flows
Effective valuation analysis involves a
disciplined 3-phase investment evaluation
process

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 Dealing with Complexity Process &
Discipline The three-phase investment evaluation process:

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 The role of project valuation

Investors

Governmental Investment
Agencies partners

Financial
Institutions

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 E-learning

Read the case of Ciscos acquisition of Linksys. on page

8 of the book: Valuation: the art and science of corporate
investment decisions. Take another example and
analyze the 5 issues to think about when making a major
investment.
Every group has to submit the exercise on 24th August,
2017.
Length: from 1 to 3 pages.

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 Summing Up

Process can be:

Very costly and time-consuming
Subject to biased estimates of project value such as
conflicts of interest and incentive problems
Affected by problems arising out of differences in the
information available to project champions and the
internal review or control group (the strategic planning
committee)

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 Looking Forward

Finance academics sometimes strip away

complexities to focus on what determines value;
sometimes creating a disconnect between what
should be done in theory and what is done in
practice.
Our study of valuation integrates the analysis of
individual projects and entire enterprises along
two dimensions. Both build upon the same
theoretical base.

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 Looking Forward

Topic Outline Structure of Text

Chapters 2-3: valuation for project valuation
Chapters 4-5: cost of capital
Chapters 6-7: review and analysis of essential
accounting issues and financial statement analysis

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 Summary

Valuation is more than about discounting cash flows and

determining NPV. Evaluating investments and acquisitions
has come along way.
Firms must consider:
Cash flow estimation
Risk assessment
Financing opportunities
The effects on earnings
Staged investments
Follow-on investments

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