Some Thoughts after a Successful NPV Analysis
The first step in the project approval process is usually a Net Present Value Analysis. Does the project make investment sense for the company? The balance of this project suggests some questions that need answers after a project shows a positive NPV.
1-Does this project maximize firm value?
In this case, the firm is considered as an entity and not as a publicly-owned company where the object is to maximize stock price. The limits the feedback provided by the security markets concerning the value of the firm. The only way of measuring the value of the firm is through some sort of pricing model such as the Capital Asset pricing model, but here the standard against which the firm that is provided by the Dow or some similar index is missing. If the firm is publicly owned, the object is to produce immediate results, which limits strategic options to some degree. (Mount Holyoke College, N.D.)
2-What will be the impact to the stock price?
The general perception of the market is that the outlook is short term. Projects which produce immediate revenues and earnings are preferred if this is the objective of the firm. There have been some studies, such as the one completed by Bernard and Thomas, which indicate that current prices do not fully reflect either current or potential future performance adequately. Their study was related to the price reaction to earnings announcement that are freely available to all. (Bernard & Thomas, 1990) This is effectively a question concerning the efficient market hypothesis and its effectiveness. Because the horizon of the study is limited, its validity is questionable. Have investors already discounted the probably information contained in the earnings release? Project recommendations based on projected stock price action are questionable.
3-How does this capital project fit with the strategic direction of the firm.
...