Strategic Investment Decisions Involving Valuable Business Opportunities

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Valuation Questions Question 1: A strategic option is a valuation approach applied by firms when making strategic investment decisions involving valuable business opportunities. The approach is premised on the idea of remedying the shortcomings of DCF analysis model. This approach allows firms to value investment opportunities by ascertaining on future value benefits that a specific project would bring to firm, rather than looking at cash flow. Strategic options enable the management to formulate strategic decisions to inform on future opportunities that would be created through today’s investments. Possible future operations are valued using strategic options, as no cash flow is analyzed, but rather analysis of opportunity for investing…show more content…
Thus, during valuation the firm must undertake strategic mapping on these elements to select real investment project. However, strategic option is subject to abuse – particularly due to absence of any formal valuation procedures. This means that strategic option can be highly politicized by the management. In practice, this valuation approach is myopic and may lead firms to undervaluing the future, and thus, to under-invest by deferring viable investment projects. Also, at times managers may use strategic options by inputting informal procedures or personal bias by deliberately championing or defending certain investment opportunities - causing overinvestment. Question 2: Adjusted Present Value (APV) approach is an income-based valuation method employed as a variant to DCF tool, but does not use any WACC calculation. By using APV method, one can ascertain enterprise value by separating out as well as accounting for tax attributes of debts/borrowing and inherent incremental bankruptcy risk associated with additional debt. During valuation, the APV approach measures a firm’s enterprise value (EV) as the value of a company devoid of debt (‘unlevered enterprise), plus prevent value of tax savings from company’s debt. Specifically, APV valuation estimates unleveraged cost of equity most often using CAPM approach, expected cash flow of an
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