Summary
Capital rationing
lMay be self-imposed (soft) or imposed by the financial market (hard).
lMay be single-period or multi-period.
lFor single-period, decision rule is: maximise the NPV per £ of capital
investment.
lFor multi-period, needs to be approached through linear programming.
Replacement decisions involve four steps
1 Derive the present value (cost) of owning the asset for each of the time
periods concerned.
2 Find (from the annuity table) the annuity factors for the relevant discount rate
and time periods.
3 Divide each of the PVs by the relevant annuity factor to derive the equivalent
annual cost (EAC).
4 The replacement period with the lowest EAC will be the most economical,
though other factors may influence the final decision.
Investment and strategy
lInvestment decisions should be taken in the context of the business’s strategic
plans.
Value-based management
lShareholder value analysis (SVA) is an approach to management that focuses
attention on the business objective of shareholder wealth maximisation and
the seven key drivers of value.
lCan also be used to value businesses.
lValue (wealth) will be enhanced by improvement in any one of seven value
drivers:
1 Sales revenue growth rate
2 Operating profit margin
3 Corporation tax rate
4 Investment in non-current assets
5 Investment in working capital
6 Cost of capital
7 Life of the projected cash flows.
lProblems of SVA:
- Possible conflicts between value drivers, so enhancing value in one area can
lead to losses of value in others. - Many businesses do not have management reporting systems that provide
the information necessary in an SVA environment.
lEVA®is an approach to management that seeks to promote businesses earn-
ing more than the shareholders’ required return and so increase value. ‘