To determine which project will bring the greatest shareholder value, use capital budgeting tools. These will allow you to calculate the cash flow for each project in the future and then compare it to its upfront cost.
The net present value (NPV), a common way to evaluate capital projects, is one of the most popular. The NPV method calculates the future cash flow projections from a capital project by subtracting the initial investment and comparing it to the expected rate of return. The project is considered a positive investment because it is likely to generate shareholder value.
The internal rate of return, also commonly used in capital budgeting is called the IRR. IRR stands for the discount rate at the which the NPV is equal to zero. This allows us to compare project returns with the desired rate of return. You can use it to evaluate projects with differing investments, lives spans and cash flows.
The Payback Period is another helpful measure. This is how long it takes for the investment money to be recouped.
You can then compare the project’s NPV, IRR, and payback time and decide which will create the highest shareholder value. Important to remember that these estimates are only estimates and future projections. They should not be taken in isolation.
In addition to performing these calculations, it’s also important that you provide a comprehensive analysis of your findings, and present them in a way that finance and non-finance stakeholders can understand. You might also discuss the limitations and assumptions of your analysis.
Overall, using capital budgeting tools, and conducting a detailed analysis of all the proposals, will allow you to provide a sound recommendation to the director for finance about which projects will add the most value to shareholders.