Company Valuation

Mueller's theory is premised on the assumption of a separation of ownership from control, shareholders seeking profit and managers seeking growth. He has argued that:" The essence of the difference between growth and stockholder welfare-maximising behaviour is the lower cost of capital or discount rate employs by the growth -maximising managers." The cost of capital or discount rate employed is lower for the managers than for the shareholders because the former consider only internal investment opportunities return on their investment. Managerial ability must be a non-specialised proclivity, and the leaders of the acquiring company must be men of much greater talent than those of the corporations they absorb. Firms that relied solely on internal growth grew on average faster than the firms with low merger intensity but more slowly those with high merger intensity.
On the other hand, non-merging firms had a strikingly better record than merging firms from the standpoint of the original shareholders. Further analysis suggested that firms engaging in pure conglomerate type mergers grew most rapidly, while firms engaging in pure internal growth grew most profitable, although growth by conglomerate type merger was more profitable than growth by other types of merger. Merger tends to be for growth, not for profitability. However, also merger is the result of the internal and external pressures and opportunities confronting the firm.
Changes in the environment in which a firm has been operating may include merger by competitors and may cause the firm's managers to experience increased uncertainty. This increased uncertainty produces a desire to merge in order to reduce uncertainty. Merger occurs if the desire to merger is accompanied by managerial ability and willingness to carry through an actual merger. Two processes are at work. Mergers occur when the relationship between firms and their environment is disturbed by changes in latter. They have suggested that the amount of competition that is acceptable is limits.
Aaronovitch and Sawyer have advocated an approach to merger that "the costs of rivalry" generated by the process of oligopolistic rivalry which fall on the firms involved and would be reduced if rivalry were reduced .The costs in question are those of undesired excess capacity, research and development and promotion and marketing. The major destabilising force to which Aaronovitch and Sawyer have drawn attention is the intensification of international competition. They have examined the relationship b-n indices of international competitiveness and merger activity. The expectation that there would be more mergers the worse the balance on current account and the higher the level of imports was confirmed. No generally agreed theory has been developed. The profit and growth maximisation hypotheses has been recast in terms of their effect on share prices and hence the probability of takeover.
Interest on the effects of merger has for the most part been motivated by welfare considerations, although more recently their role in shaping the longer term evolution of the socioeconomic system. Cook and Cohen have pinpointed the general difficulty in the introduction to their detailed case studies: "mergers are a reaction to a changing situation. Judgement depends upon comparing the effects of what actually happened with the effects of what might have happened.
Sensitivity analysis is the process of varying the assumptions underlying a decision to determine the decision's sensitivity to those assumptions. It enables managers to assess how responsive NPV is to changes in key variables that are used to calculate it (Drury 1996). Some of the factors that influence the NPV of multinationals are taxes, exchange rates, estimating the terminal value of a project using different methodologies, political risk and the real operating options (Buckley 2000). NPV is calculated using the estimated value of sales, unit to be sold and growth rates. Taking each variable one at a time, the NPV can be computed separately to know what the NPV will be if that variable changes. In order to perform a sensitivity analysis, the firm will need to first pick a base case situation as benchmark for comparison. After picking the base situation, the firm will start changing one of its key variables and determine its impact on the project's NPV.
Sensitivity analysis gives some idea of stand-alone risk as variables are analysed on their own. Stand-alone risk is the risk the project has by being considered as a separate project. Since a project by a multinational has 'knock on' effects on other projects in the group, there is the need to analyse the NPV of the project without taking the effects on other subsidiaries. The Chilean or Indian project has to be evaluated as a stand-alone project to determine its real NPV.
It also identifies dangerous variables that will impact negatively on the business. This gives managers immediate answers about possible future events and their influences on NPV. By doing sensitivity analysis, variables that seen as dangerous are identified and managed so as to reduce its impact on the business (Horngren et al 2002)
Sensitivity analysis gives some breakeven information. Breakeven analysis is concerned with the relation between sales volume and profitability. By changing variables and assessing their effects on cash flow and profitability, a lot of information can be gained to analyse how different variables impact on profitability. By doing sensitivity analysis, each of the variables has to be examined to see by how much the estimated figure could be changed before the project becomes unprofitable for that reason alone (Atrill 2003)
Sensitivity analysis does not take into consideration the effect of sister companies and how the output of one subsidiary has an effect on the output of others. It doesn't take the issues of transfer pricing and the fact the transfer price can be lower that the actual price. It makes no attempt to analyse risk in any formal way. Nor does it give any indication as to what the decision maker's reaction should be to the data presented in a sensitivity table (Lumby 1994) Sensitivity analysis manipulates one variable to determine the NPV of a project. Each component is varied in turn whilst all others are held constant. The degree of sensitivity only holds if all the other estimates turn out to be accurate. Thus it ignores the possible effects on the decision of two or more of the estimated components varying simultaneously (Lumby 1994). This is hardly the situation in the real world as variables are dependants on each other. It doesn't give a real picture but only a "what if” picture.
There have been strong theoretical arguments in favour of analysing any foreign project from the parent company's point of view (Eiteman 2001). This is because it is only cash flow to the parent company that can be used to pay dividends to shareholders and for corporate reinvestment. The purpose of investment is to maximise shareholders wealth and therefore there is the need to evaluate projects from the parent company's viewpoint as against the subsidiary's viewpoint.
Some of the arguments for analysing a project from the view of the subsidiary include the need to evaluate a subsidiary's performance when the financial package of manager's is performance related. Analysing a project from the view of the parent does not give a good picture of the performance of the subsidiary. It can also be used to determine the performance of subsidiaries if the project is viewed from the subsidiary's point. There can be a basis to compare it with other projects in the subsidiary's country. This will give a clearer picture about the performance of the subsidiary than viewing it from the parent's point. Attention should be paid to competing projects and local returns. Another issue to consider in project evaluation is the effect the project has on the multinational company as a whole. This can be viewed in the sense of the knock on effects and transfer pricing. An example of the knock on effect is cannibalisation where the new project takes sales away from the firm's existing products. Thus, the building of a project in India or Chile may end up substituting local production for exports from Australia. If you are looking at it from the subsidiary's viewpoint, it may be a worthwhile project but it may be taking sales from a sister company.
The next issue to consider when evaluating project is transfer pricing. Transfer pricing is the price that multinational companies sell amongst subsidiaries. It can be set either at cost or market prices. The aim of using transfer pricing is to generate the maximum profit for a multinational company. In evaluating projects, the issue of transfer pricing should be taken into consideration, as some subsidiaries have to sacrifice for the benefit of the group. If there are issues of transfer pricing involved between the Indian and Chilean subsidiaries and the Australian parent, it will affect the cash flow and the NPV of each project. The Australian parent may be selling at a transfer price that will make the Indian or Chilean subsidiary have cash flows for the benefit of the group. If the project is analysed from the subsidiary's view, it may be have a positive NPV but there may have been sacrifices by sister companies in the form of transfer prices.
Another issue that has to be taken into consideration in project analysis is whether there is restricted remittance in the subsidiary's country. If there is restricted remittance, then whatever profit is made may not be remitted to the parent and this does not satisfy shareholders motive for investment. Rodriguez and Carter (1984) argue however, that analysis in respect of remittable funds is neither here nor there. They argued that the multinational company could make long term continuing investment in the country and the restriction on repatriation become irrelevant. But that view by Rodriguez and Carter is less than acceptable, as multinationals should focus upon remittable cash flows from a project although there may be avenues for blocked funds to be unblocked. However, the value of a project is in the cash flow that can be remitted to the parent. Thus investing in India or Chile and determining the various cash flows and the net present value is not relevant if those cash flows cannot be repatriated. It is only repatriated funds that maximise shareholders value. Though the Chilean project has a positive NPV of A$10M as against the Indian project's positive NPV of A$12M, it doesn't necessarily mean that the Indian project is better. These should be put into context with how much of that positive NPV can be remitted to the parent company. If there are policies that doesn't allow for the remittance of money from India, the parent company has no use for the higher positive NPV of A$12M generated.
In analysing a project, the perspective should be from the parent company's viewpoint as it is only remitted funds that are of importance to shareholders in their wealth maximisation motive. This can be viewed from the incremental revenue contributed by the project. The incremental revenue contributed by a project to the parent company can be significantly different from the project revenue and cash flow. Economic theory suggest that the value of a project should be determined by the NPV of future cash flows that can be remitted to the investor because it is only accessible funds that can be used to pay dividends and interest (Shapiro 1999). However, project cash flows are first to be computed from the subsidiary's viewpoint as if the subsidiary is a separate company. The analysis then moves into specific forecast concerning the amounts, timing and form of transfer to the parent company as well as information about taxes and transfer expenses. Finally there should be the recognition of the indirect benefits and costs that the project confers on the rest of the system, such as an increase or decrease in export sales
View of the parent as it is only remitted cash that can be used to pay dividend to shareholders and further investment in other companies.
The use of NPV as an investment appraisal technique argues that projects with positive NPV should be accepted whilst negative NPV projects should be rejected. The most desirable property of NPV is that it evaluates investments in the same way as a company's shareholder. It is consistent with the shareholder wealth maximisation theory (Shapiro 1999). It also obeys the value additive principle i.e. the NPV of various projects is the sum of the NPVs of the individual project. However, in multinationals, projects are rarely mutually exclusive. It is difficult to calculate the inflows of a project in Multinational Company since the project may have an impact on the operation of other subsidiaries. What is therefore of importance to a multinational company is not the project cash flow but the incremental cash flow generated by the project. Some of the factors that may affect the NPV analysis are transfer pricing, taxes, exchange rate fluctuation and controls, and political risk. International project appraisal needs to take all these into account and these have to be discounted at the appropriate risk-adjusted opportunity cost of capital (Buckley 2000).
In multinational investment projects, the type of financing package is often critical in making otherwise unattractive projects attractive to the parent company. Thus, cash may flow back to the parent because the project is structured to generate such flows via royalties, licensing fees, dividends, and so on. Unlike in domestic capital budgeting, operating cash flows cannot be kept separate from financing decisions.
Another added complexity in multinational capital budgeting is the significant effect that fluctuating exchange rates can have on the prospective cash flows generated by the investment.
From the parent's perspective, future cash flows abroad have value only in terms of the exchange rate at the date of repatriation. Differing rates of national inflation and their potential effect on competitiveness must be considered. Inflation will have the following effects on the value of the project, as it will impact the local operating cash flows both in terms of the prices of inputs and outputs and also in terms of the sales volume depending on the price elasticity of the product. It will also impact the parent's cash flow by affecting the foreign exchange rates and affect the real cost of financing choices between foreign and domestic sources of capital. In conducting the analysis, it is necessary to forecast future exchange rates and to conduct sensitivity analysis of the project's viability under various exchange rates scenarios.
It is only after tax cash flows that are relevant to a multinational. It is therefore necessary to determine when and what taxes must be paid (Shapiro 1999). When investments are appraised from the parent standpoint, profits arise out of the investment in the host country i.e. India or Chile fall into the local tax net. Then on distribution, they are subjected to withholding tax and finally in the home country i.e. Australia, they may fall into another tax net (Buckley 2000). There is therefore the need to take the tax system and structure in India and Chile into consideration in choosing the better of the two projects.

References
Aaronovitch, S. and Sawyer, M. (1974) 'The Concentration of British Manufacturing', Lloyds Bank Review, no. 114
Atrill, P. (2003) financial management for non-specialists, Harlow: Prentice Hall.
Buckley, A. (2000) Multinational Finance. 4th ed., Harlow: Financial Times Prentice Hall.
Clark, E. Levasseur, M. Rousseau, P. (1993) International Finance, London: Chapman and Hall
Drury, С (1996) management and cost accounting, 4th ed., London: Thomson Business Press.
Eiteman, D.K., Stonehill, A.I., Moffett, M.H. (2001) Multinational business finance, 9th ed., Reading: Longman
Horngren, C.T., Sundem, G.L. and Stratton, W.O.I (2002) Introduction to Management Accounting, 12th ed., New Jersey: Prentice - Hall International
Lumby, S (1994) Investment Appraisal and Financial Decisions, 5th ed., London: Chapman and Hall.
Madura, J. (2003) International Financial Management, 7th ed., Ohio: Thomson
Mueller C.M. (eds.) & A.D. Morris: 2005: Frontiers' in social movement theory. New Haven, CT: Yale University Press. 156-173
Ross, S.A., Westerfield, R., Jaffe, J. (1999) Corporate Finance, 5th ed., London: McGraw Hill.
Rodriguez, R. and Carter, E. (1984) International Financial Management, 3rd ed., Englewood Cliff, New Jersey: Prentice Hall.
Shapiro, A. C. (1999) Multinational Financial Management, 6th ed., New York: Wiley

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