How capital budgeting decisions affect a company’s value, Finance Basics

Give an example of how capital budgeting decisions affect a company's value, strategy or operations.

  • Companies always tend to look for capex projects which will add value to the company. Any project which will enhance the value to the stakeholder will attract the company.
  • For eg - there is a steel making company which is heavily dependent on a third party iron -ore supplier, which is the most important raw material for manufacturing steel. The supplier increases the price of the iron - ore on its whims and fancy. This leaves the steel manufacturer on the mercy of the supplier and also suppresses its profits
  • The steel manufacturer decides to purchase an iron ore mine. For this it does the capital budgeting analysis of mining expenses, quantity of iron ore, onetime cost of acquiring the mine etc . The steel manufacturer found out that the cost of iron ore is coming significantly lower than the price paid to the supplier.
  • The steel manufacturer went ahead with acquiring the mine and saw its profits increased substantially. This lead to increase in the share price and consequently lead to increase in shareholder's wealth. This lead to increase valuation of the company.

 

 

Posted Date: 9/17/2012 9:34:00 AM | Location : United States







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