The Valuation of a Firm With Alternative Projects

The Valuation of a Firm With Alternative Projects

Cem Berk (Kirklareli University, Turkey) and Mustafa Dilmen (Infratech Industrial Heating Systems, Turkey)
Copyright: © 2020 |Pages: 15
DOI: 10.4018/978-1-7998-1086-5.ch014


The value of a firm is equal to the value of all projects in its assets. Investment decision is taken based on expected costs, knowledge of techniques, and risk perception; all of which are parameters of firm valuation. The research in this chapter is based on a real company in the household appliance industry. The company has a factory storage in Istanbul, Turkey. Two alterative heating projects (infrared and natural gas) are developed for the storage space according to project characteristics and heating requirements. The initial investments and operating costs are determined by market prices. According to the results, electric infrared heating is most of the time more favorable when the ceiling is high. An investment decision specifically for the factory storage is made. A discussion section on results is also available. Heating and cooling is a strategic industry for European Commission. The research can guide academicians and practitioners in this field.
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Laro and Pratt (2011) point out that the first step in determining the value of a firm is to define the concept of value. Although the most relied definition is fair value, there are others such as investment value, intrinsic value, and transaction value. Fair value is defined as the current value in a market where both buyer and seller are willing and knowledgeable and they are not in a rush to buy and sell. Investment value is the value specific for an investor. Especially for firms, the value of a firm may be different for different investors due to synergy considerations. Intrinsic value is the theoretical value that is independent from market conditions and is likely to be computed by an analyst. Transaction value requires a history of previous sales where the firm or benchmark firms are sold either completely or partially.

According to Matschke et al. (2010) valuation is the process of determining a value for a specific valuation object for someone who is interested in the value of valuation object which is most of the time monetary. For the purposes of this book, valuation refers to firm (also called as business, or company). The valuation may be for the whole firm or for the part of it such as a facility, project or division, and shares of the company.

Mercer and Harms (2008) argue that the value of a firm can be best determined by the current value of all cash flows to the firm which are forecasted with the assumption that the firm has infinite life and discounted to today where project risks are considered.

As explained by Feldman(2005), several issues arise while valuing a private firm. Some of these include deciding which valuation technique is adequate, determining the amount of discount buyers may demand in the market, valuing affiliates, tax considerations and method to determine cost of capital.

According to Damodaran (2001) there are three approaches to valuation. The first one is discounted cash flow which is previously mentioned. The second one is relative valuation which requires the use of one / combination of multiples and benchmark firms. And the third one is contingent claim valuation where option pricing model is used.

The value of a firm is equal to the net present value of the all of the projects which it has in its assets. Kodukula and Papudesu (2006) think that project valuation is a critical process where a dollar value is determined for a project. They think that a proper project valuation require to subtract life time project costs from project revenues. The important factors for project valuation are to determine the initial and operating phase cash flows for the entire project life, discount rate, and availability of management decisions. These decisions (“real options”) include deferring, abandoning, expanding, and contracting the project.

Investment decision is one of the core concepts of corporate finance. Virlics (2013) thinks that investment decision is taken based on expected costs, knowledge of techniques, and risk perception all of which are parameters of firm valuation. Investment is an allocation of resources. And since the resources are scarce, it is crucial to allocate the funds to correct project/ projects to avoid bankruptcy.

Lukashevich et al. (2018) see investment decisions as often being a selection of alternatives under constraints. In firm valuation, we have budgetary constraints among alternative projects. It may not possible to operate with multiple projects in parallel. Moreover, in some projects, accepting a project might mean rejecting the alternative because the alternative is no longer necessary to apply or there are technical constraints such as lack of space, license, equipment and staff. These projects are mutually exclusive. Therefore, the most attractive project needs to be chosen. The alternative investment projects may be selected based on a combination of capital budgeting techniques such as net present value, profitability index, internal rate of return, return on investment and payback period.

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