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Dec 2009

A capital idea

When it comes to maximising the net present value to shareholders which can be obtained from a given net present value of the entity, there are a number of interrelated factors to consider.

There are so many variables, especially from one time frame to another, that it would be quite vain to hope for a precise answer which stood for all time.

The sensible approach is to construct a model which culminates in the value of the company to its shareholders.

An assumption of maintaining the current ratio of borrowings to equity would be where most people would start, but then the idea would be to test a few variations on the theme, so as to identify what appears to be the best – and then be prepared to revisit the question as and when conditions demand. In the order that they would most likely be entered into the model, the key components are as follows.

The base data would, of course, be the projected cash generation of the enterprise. As defined in last month’s article, this represents the forecast excess of receipts from customers over payments to suppliers and employees.

It needs to be separated on the basis of the rules of taxation, as opposed to accounting standards, into its two components:

  • Profit, before depreciation minus capital allowances
  • Expansion, the increase in net current assets plus the excess of capital expenditure over capital allowances.

A capital idea