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Abstract
Projects are financial and strategic investments that exist to deliver value. Cash flow modeling is a required and essential
step to produce return on investment (ROI) financial measurements that support the project selection process. Examined
are finance topics, specifically six key questions non-financial personnel need answered at the onset of the process if they
are to produce reliable and accurate cash flow models to transform the project manager into a strategic value-enabler and
profit creator.
Equity
Equity represents another source (and more costly form) to
fund projects and business operations. Corporations can
secure funds by selling stock (or by utilizing retained earnings
from business operations, another form of equity). In return
for their investment dollars, shareholders receive ownership
interest in the company, but they also expect a reasonable (or
better), financial return on their investment (e.g., stock price
appreciation, dividend payouts). Company directors may
know that if the company provides an overall annual return
to investors (of some amount, lets say 8%) they are likely to
remain happy and to stay as investors. Companies must meet
the financial expectation of shareholders; otherwise, they will
unload their shares, causing the stock price to drop. This is
the cost of equity (also expressed as a percentage), and is
essentially what it costs the company to maintain a share price
theoretically acceptable to investors, e.g., the 8%.
Capital Structure
For reasons not relevant here, some businesses find that it
makes more sense to purchase items by incurring debt (bank
loans), and for others, to use cash (equity financing, selling
stock). The balance between debt and equity funding signifies
the companys capital structure; it represents the percentage of
debt and percentage of equity a company maintains to fund
its projects and run day-to-day business operations. Capital
structure can vary greatly from one company to another or
from one industry to another (e.g., 30% debt to 70% equity
structure for one company and 50% debt to 50% equity
structure for another, or variations thereof ).
Weighted Average Cost of Capital and its Relevance
We are now ready to explore the financial metric called
weighted average cost of capital. WACC is a measurement
that refers to the capital structure of a company. It is a
proportionately weighted calculation that brings together the
weighted cost of debt and the weighted cost of capital (into
one number) used to express an overall interest rate for a
company to meet its obligations to financial institutions and
shareholders. For example, WACC = 14.75%.
A specific company may have a 30% debt capitalization
at 8.2% (the blended interest rate) and a 70% equity
capitalization at 14% (rate shareholders kept happy, remain
as investors). It is from these numbers the WACC is derived.
Note: The required rate of return on debt is after tax.
Works Consulted
Berman, K., Knight, J. & Case, J. (2006). Financial
intelligence: A managers guide to knowing what the numbers
really mean. Boston, MA: Harvard Business School
Publishing.
Callahan, K. R., Stetz, G. S., & Brooks, L. M. (2007).
Project management accounting: Budgeting, tracking, and
reporting costs and profitability. Hoboken, NJ: John Wiley &
Sons, Inc.
Resch, M. (2011). Strategic project management
transformation: Delivering maximum ROI & sustainable
business value. Fort Lauderdale, FL: J. Ross Publishing Inc.