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Generally in all decisions concerning investments in capital projects, the management selects only those projects that are expected to contribute a positive net present value. Further the project should be capable of providing an internal rate of return which should be greater than the hurdle rate. (Ross et al 2005) These criteria for the selection of capital projects are considered valuable from the perspective of the evaluation of the capital projects.
However the phenomenon of value maximization of the firm is not being focused by these evaluation methods. It may be noted that a project will be considered financially viable only when it satisfies the condition of meeting the evaluation criteria and should also be in a position to provide super-normal returns on the investments to add value to the business proposing the investment. Several avenues can be cited which could be used by the project to result in super normal profits to the firm which results in the enhancement in the value of the firm.
To cite a few avenues; by ensuring better economies of scale, by providing other cost advantages, by enabling the firm to offer better quality products that are distinct in the market, by improving production efficiency, by providing better access to distribution channels and by ensuring increased brand recognition the new project investments would be able to add value to the firm.
Project Investment and Stock Valuation The potential for growth and improvement in sales of the company will significantly be impacted by the proposed expansion of the company into new markets and new product lines and this will improve the position of the company in terms of profitability and return on equity. As a natural consequence the expansion by achieving the projected financial expectations will impact the value of the company’s stock. The market value of the stock is likely to go up once the expansion pays off the results by way of increased profits.
Further the internal valuation of the shares will also get increased or decreased depending on the financial decision for sourcing the additional funds required for investing in the capital projects. Based on the changes in the leverage the book value of the shares will be affected. When the company decides to finance the expansion through issue of new common stocks the equity will get diluted to the extent of the stocks issued for public subscription.
This in turn will have its impact on the free cash flow to the equity, since there will be increase in the number of shares and therefore the valuation of shares will get impacted. (Discussion Issues and Derivations) Strategic Considerations Normally the execution of any project investment decisions can be influenced by the governmental regulations on which the management does not have any control. But there are certain other factors, the course of which can be altered by taking some strategic decisions by the management.
By selecting those projects which offer the best return on investment through better economies of scale the management can strategically increase the returns and value of the firm. The other alternative is to look for avenues that will enable the company to enlarge the economies of scale on the existing operations of the firm Improving the quality of customer service and timely deliveries to the customers has been found to be proven strategies for improving the reputation of the firm and thereby improving the value of the firm.
Establishment of unique and efficient distribution channels much above the ability of the competitors to achieve can be looked at as another strategic move. In making any project successful an important factor is the quality of the management and the ability to take strategic and tactful decisions. It is essential that the quality of management must be related to the quality of projects the firm is contemplating to invest in.