Question
After taking a closer look at the numbers and doing the financial analysis, you begin to think more strategically, and in a broader context, you anticipate what the CFO would ask or what the head of Strategic Planning might want to know. You think about some of the key issues:
•Does this project maximize firm value?
•What will be the impact to the stock price?
•How does this capital project fit with the strategic direction of the firm?
In light of this, you decide to email the CFO and VP of Strategic Planning in anticipation of their questions.
Explain how capital projects maximize firm value. Explain how major capital projects can impact a firm’s stock market valuation and how they should fit with the strategic direction of the organization.
Explanation / Answer
Impact of capital projects on value of the firm: The impact of capital projects on the value of the firm can be determined using the preent value techniques. In general sense investing in capital projects leads to fall in the short term profitability. The project may be very useful to the long term profitability of the concern or it may have positive Net present value, the decline in the short term profits will leads to the rejection of such projects. The capital projects which are potential enough will generate more cash inflows, obviously the increase in the cash inflows leads to the increase in the profits. The increase in the profits will generate more effecient financial results to the public and all. The positive financial results will result in the increase of the value of the firm. - The increase in the value of the firm will obviously result in the increase in the stock price. The price of the stock is depend upon the value of the firm as well as the profitabiity of the firm. When there is a high value for the firm, the value of the stock will increase at a higher rate. There may be negative effects according to the dercline in the value of the firm. - The strategic direction of the firm depends upon the stage of the company in the life cycle. According to the strategic direction of the firm, the firm take actions regarding the expansion or sell off of the units. The take up of capital project should fit with the strategic direction of the firm. When the firm has the objective of expansion, it has to act according to the objecctive. Here the company has to purchase new plants or new machinery which will generate more cash inflows. Here the company has to analyse the investing opportunities using the present value techniques. The mis macth of the objective and the action taken by the company will result in the short term as well as long term financial deficit. The capital projects should fit with the strategic direction of the concern by the way of providing adequate cash inflows, to meet the working capital requirements. The impact of capital projects on the value of the firm can be determined using the preent value techniques. In general sense investing in capital projects leads to fall in the short term profitability. The project may be very useful to the long term profitability of the concern or it may have positive Net present value, the decline in the short term profits will leads to the rejection of such projects. The capital projects which are potential enough will generate more cash inflows, obviously the increase in the cash inflows leads to the increase in the profits. The increase in the profits will generate more effecient financial results to the public and all. The positive financial results will result in the increase of the value of the firm. - The increase in the value of the firm will obviously result in the increase in the stock price. The price of the stock is depend upon the value of the firm as well as the profitabiity of the firm. When there is a high value for the firm, the value of the stock will increase at a higher rate. There may be negative effects according to the dercline in the value of the firm. - The strategic direction of the firm depends upon the stage of the company in the life cycle. According to the strategic direction of the firm, the firm take actions regarding the expansion or sell off of the units. The take up of capital project should fit with the strategic direction of the firm. When the firm has the objective of expansion, it has to act according to the objecctive. Here the company has to purchase new plants or new machinery which will generate more cash inflows. Here the company has to analyse the investing opportunities using the present value techniques. The mis macth of the objective and the action taken by the company will result in the short term as well as long term financial deficit. The capital projects should fit with the strategic direction of the concern by the way of providing adequate cash inflows, to meet the working capital requirements.