Value Creative Investment Criteria
In a bid to unlock corporate value in Japan, in this book, the author proposed “Three Pillars of Financial Strategies” such as Equity Spread and Value Creation, Value-Creative Investment Criteria, Optimal Dividend Policy based on Optimal Capital Structure. If a company is to grow in the future on a sustained basis, it has to invest in its businesses, including but not limited to R&D, human capital, factory equipment, infrastructure for organic growth or acquire other companies, business units, products, intangibles such as patents, in-process R&D and marketing rights for external growth. With that said, how can a company ensure value creation and fulfill the duty of accountability and stewardship to its stakeholders, especially shareholders? This chapter suggests, as the second financial strategy, that firms must adopt risk-adjusted hurdle rates for individual projects to secure value-enhancing Equity Spread (ES), which is the investment return over capital cost. A yield exceeding the cost of capital creates corporate value in consideration of capital expenditures, M&A, and even cross-shareholding. To foster dialogue with investors, corporate managers must explain their process of value creation and set investment criteria considering the cost of capital. The capital expenditures budget underwrites corporate growth, and budgeting requires criteria for estimating corporate value creation versus cost of capital. Yoshida et al. (2009) show that net present value (NPV) and internal rate of return (IRR) are the criteria for comparison in the U.S., UK, Germany, and the Netherlands, but 83% of Japanese firms adopt a simple payback period (SPP) as their criterion. That is, Japanese companies tend to make investments without considering the cost of capital due to the lack of consciousness of opportunity cost borne by shareholders. Drawing from the author’s experience as a CFO and a certified managerial accountant (USCMA), this chapter proposes adopting risk-adjusted hurdle rates (for example 200 kinds of hurdle rates are illustrated) to determine NPV and IRR in a bid to improve capital efficiency and meet fiduciary duty, the same goal Abe’s Corporate Governance Code seeks to achieve.
KeywordsValue-creative investment criteria Risk-adjusted hurdle rates NPV IRR SPP Capital cost M&A PI
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