This book presents a new approach to the valuation of capital asset investments and investment decision-making. Starting from simple premises and working logically through three basic elements (capital, income, and cash flow), it guides readers on an interdisciplinary journey through the subtleties of accounting and finance, explaining how to correctly measure a project’s economic profitability and efficiency, how to assess the impact of investment policy and financing policy on shareholder value creation, and how to design reliable, transparent, and logically consistent financial models.
The book adopts an innovative pedagogical approach, based on a newly developed accounting-and-finance-engineering system, to help readers gain a deeper understanding of the accounting and financial magnitudes, learn about new analytical tools, and develop the necessary skills to practically implement them. This diverse approach to capital budgeting allows a sophisticated economic analysis in both absolute terms (values) and relative terms (rates of return), and is applicable to a wide range of economic entities, including real assets and financial assets, engineering designs and manufacturing schemes, corporate-financed and project-financed transactions, privately-owned projects and public investments, individual projects and firms.
As such, this book is a valuable resource for a broad audience, including scholars and researchers, industry practitioners, executives, and managers, as well as students of corporate finance, managerial finance, engineering economics, financial management, management accounting, operations research, and financial mathematics.
It features more than 180 guided examples, 50 charts and figures and over 160 explanatory tables that help readers grasp the new concepts and tools. Each chapter starts with an abstract and a list of the skills readers can expect to gain, and concludes with a list of key points summarizing the content.
Author(s): Carlo Alberto Magni
Publisher: Springer Nature Switzerland AG
Year: 2020
Language: English
Pages: xxii+742
About the Author
Contents
Preface
Potential Readers
Some Methodological Remarks
Terminology
Logical Structure of the Book
Table of Contents Overview
Acknowledgements
Part I Accounting-and-Finance Engineering System: The Mechanics
1 Dynamics. The Law of Motion
1.1 The Three Basic Notions
1.2 The Income Rate and the Time Value of Money
1.3 Investment or Financing
1.4 The Project as an Incremental System
1.4.1 Expansion Projects
1.4.2 Abandonment Projects
1.4.3 Replacement Projects
1.5 Key Points
2 Statics. The Law of Conservation
2.1 Investment Side and Financing Side
2.1.1 Equilibrium of Capital Values
2.1.2 Equilibrium of Incomes
2.1.3 Equilibrium of Cash Flows
2.1.4 Equilibrium of Income Rates
2.2 Financial Structure and Capital Structure
2.3 Borrowing from the Project versus Borrowing from Debtholders
2.4 Key Points
Part II Accounting-and-Finance Engineering System: The Matrix
3 Financial Statements
3.1 The Breakdown and the Matrix: Starting Steps
3.2 Operating Assets
3.2.1 Decomposing Operating Assets, Income, and Cash Flow
3.2.2 Cost of Goods Sold
3.2.3 Splitting Up Operating Costs and Liabilities
3.2.4 Operating Cycle and Cash Cycle
3.3 Non-operating Assets
3.4 Debt
3.5 Equity
3.6 The Split-Screen Technique
3.6.1 The Working Rules
3.6.2 Rule 7: Recording Transactions
3.7 Reconciling the Matrix with the Standard Financial Statements
3.8 A Managerial Perspective on COGS
3.9 Cost-Volume-Profit Analysis: An Engineering Perspective
3.10 Key Points
4 Estimating the Cash Flows
4.1 Cash Flow from Operations
4.2 Cash Flow from Assets
4.3 Cash Flow to Equity
4.4 The Last Cash Flows
4.5 The Project as a Split-Screen Film
4.6 Taxes and Depreciation Tax Shield
4.7 NOPAT and Free Cash Flow
4.8 Unlevered Operating ROI
4.9 The Asset FCF
4.10 Potential Dividends
4.11 The Mosaics of Incomes and Cash Flows
4.12 Key Points
Part III Valuation and Decision-making: The Absolute Approaches
5 Valuation and Value Creation
5.1 The Law of One Price
5.2 A Benchmark System
5.3 Rational Decision-Making and Net Present Value
5.4 Cost of Capital
5.5 Considering Risk
5.6 Cost of Capital in Practice
5.7 Key Points
6 Project Appraisal
6.1 Valuing Projects with Cash Flows: Levered Perspective
6.1.1 Valuation in a Financing Perspective
6.1.2 Valuation in an Investment Perspective
6.2 Valuing Projects with Cash Flows: Unlevered Perspective
6.2.1 FCF and the WACC Method
6.2.2 FCF and the APV Method
6.3 Valuing Projects with Cash Flows: Modified Discounting
6.3.1 Modifying CFEs
6.3.2 Adjustment Factors and Circularity
6.4 Valuing Projects with Cash Flows: Potential Dividends
6.5 Summary of 12 Discounted-Cash-Flow Valuation Methods
6.6 Valuing Projects with Incomes
6.6.1 Residual Income
6.6.2 Residual Income Valuation
6.7 Valuing Projects with Capitals
6.7.1 The Three Benchmark Systems
6.7.2 Value Added or Net Future Value
6.8 The Absolute Approaches and the Basic Notions
6.9 Key Points
Part IV Valuation and Decision-Making: The Relative Approaches
7 The Quest for a Relative Approach
7.1 Absolute or Relative Measures of Worth?
7.2 The Capital: A Link Between Absolute and Relative Measures of Worth
7.3 Key Points
8 Average Internal Rate of Return
8.1 Building the Rate-of-Return Notion Intuitively
8.2 Coherent Rates, AIRR, and Rational Decisions
8.3 Coping with Time-Varying COCs
8.4 The Book AIRRs
8.5 Equal Cash Flows, Different Rates of Return
8.6 The AIRR and Excess AIRR Functions
8.7 The Profitability Index and the Benefit-Cost Ratio
8.8 The Economic AIRR
8.9 Mixed Projects: Investment-Period NPV and Financing-Period NPV
8.10 Key Points
8.11 Appendix: Underdetermination of Rate of Return by Cash Flows
9 Internal Rate of Return
9.1 IRR and Chisini Mean
9.2 IRR and AIRR
9.3 The Classical Pitfalls of IRR
9.4 The Practical Relevance of the Classical Pitfalls
9.5 Other Mishaps of IRR
9.6 The Modified IRR (MIRR) and the Sinking Fund Methods (SFMs)
9.7 The TRM Model
9.8 Popularity of IRR with Practitioners
9.9 Key Points
10 Internal Average Rate of Return and Aggregate Return on Investment
10.1 IARR
10.2 The Book IARRs
10.3 The Average ROE and the Equity COC
10.4 Cash Multiple and Modified Dietz
10.5 Aggregate Return on Investment
10.6 The Six Approaches and the Three Pairs of Glasses
10.7 Key Points
Part V Project Selection and Some Final Examples
11 Ranking Projects
11.1 Project Ranking with Absolute Measures of Worth
11.2 Project Ranking with Relative Measures of Worth
11.3 Incremental Analysis
11.4 Direct Method
11.5 Key Points
12 Three Decisions
12.1 Bumps Inc. (IARR and NPV)
12.2 HomeNet Project (AIRR and RI)
12.3 Rainbow Educational Program (AROI and NFV)
References
Symbols and Abbreviations
Index
