Evaluation of Investments in Open Innovation Ventures

Evaluation of Investments in Open Innovation Ventures

DOI: 10.4018/978-1-5225-5721-0.ch007

Abstract

There are many concepts in the discipline of investment finance for evaluating investment in open innovation projects. Some of the concepts are cost benefit analysis, opportunity cost, activity-based costing, and capital budgeting. Every concept needs a certain parameter for analysis before investing in a project. This chapter gives an overview of the above concepts. Further, this chapter adopts a simplified approach in applying the above concepts for evaluating the various open innovation projects discussed in the case illustrations in this book.
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Introduction

It is general practice in business enterprises to find out the anticipated returns on the amount to be spent as invested by them (Belderbos & Faems, 2010). Projected cash flows and profit and loss statements are prepared to assess the worthiness of the project before a venture starts. Investment proposals are prepared relating starting a business venture, acquisition of latest machinery, designing and developing new products, and research and development projects (Prasana, 2011). Depending on the type of venture by an enterprise, the one of the concepts such as cost benefit analysis, opportunity cost, activity based costing and capital budgeting is applied to evaluate the investment in a business venture (Marshall & Bansal, 2011). The above concepts are briefly explained below.

  • 1.

    Cost Benefit Analysis: All estimated costs and expenditure in the proposed venture are taken into account. The benefit is likely to be derived from a particular business venture will be evaluated for taking investment decisions.

  • 2.

    Opportunity Cost: A benefit, profit or value of something is given up to acquire or achieve something else. Resources such as land, money, time, and other assets can be put to alternative uses. Every action, choice, or decision is foregone to achieve something else has an associated opportunity cost (Banerjee, 2010).

  • 3.

    Activity Based Costing: Activity based costing is a costing methodology that identifies activities in an enterprise and assigns the cost to each activity with resources to all products and services according to the actual consumption such as material and service. Apportioning of a cost or incurring cost, in a particular activity later it is related to each activity cost to outputs (Ramachandran & Kalani, 2011).

  • 4.

    Capital Budgeting: Capital budgeting method is applied to determine whether an enterprises’ long term investment in new machinery, replacement of a machinery, designing and developing new products, and research and development projects are worth funding of cash or not.

Time value of money is important in capital budgeting decision. It allows business enterprises to adjust cash flows for the passage of time. This process is known as discounting to the present value and allows for the preference of dollars received today over dollars to be received at a later date.

Cost of capital is an important element in capital budgeting method. It stresses the minimum rate of return an enterprise must earn on its investments in order to satisfy the expectations of investors who provide the funds to the enterprise (Sofat & Hiro, 2011). It is often measured as the weighted arithmetic average of the cost of various sources of finance tapped by the enterprise. They are three rules followed by the discounted cash flow method. They are net present value, (2) internal rate of return, and (3) profitability index. In the case of net present value, the rule says acceptance of net present value is greater than zero. Internal rate of return suggests acceptance of internal rate of return is greater than the cost of capital. Profitability index stresses greater than one.

Following paragraphs provide an idea in relating the parameters for applying the right type of financial concept in evaluating open innovative venture from the perspective of finance.

In the chapter titled “Role of Virtual Reality in Open Innovation Initiatives”, three case illustrations are discussed.

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