3.18.1 Calculate npv with glance of inflation

The formula linking the nominal interest rate (rn) and real rate (rr) is:

where ri - inflation rate (3.11).¹⁷

If the discount rate is started in nominal terms, then consistency requires that cash flow be estimated in nominal terms. Of course, there is nothing wrong with discounting real cash flow at a real discount rate. In fact, this is standard procedure in counties with high and volatile inflation.

Suppose managers firm forecasts cash flow in nominal terms and discounts at a 15 percent nominal rate, but managers are given project that cast flows have to estimate in real terms. Manager has two alternatives: either restates the cash flows in nominal terms and discount at 15 percent, or restate the discount rate in real terms and use it to discount the real cash flow.

Real cash flows ($)
C0	C1	C2	C3
-100	+35	+50	+30

Table 3.12

Manager should understand that it has to discount nominal cash flows at a nominal discount rate and discount real cash flows at a real rate and never mix it. Assume that inflation in project would be at 10 percent. Then the cash flow for year-1 will be 35,000x1.10 = $38,500. The cash flow for year-2 will be 50,000x (1.10) (1.10) = $60,500 and so on. If manager discount these nominal cash flows at the 15 percent nominal discount rate, manager have

NPV = or $5,500

Instead of converting the cash flow forecasts into nominal terms, manager could convert the discount rate into real terms by using the following formula:

(3.12)

where rr - real discount rate;

rn - nominal discount rate;

ri - inflation rate.

In example this gives:

Real discount rate = or 4.5%

It is discounted the real cash flows by the real discount rate:

NPV = or $5,500

It has NPV just as before. Manager should note that real discount rate is approximately equal the difference between nominal discount rate and the inflation rate.

3.18.2 Calculating npv in other countries and currencies

A sometimes manager has to make decision about invest project in a foreign countries it is created a few differences that arise from the change in project location:

1) The cash flows that are forecasted have to set in currencies of location the project.

2) The cash flows that are forecasted needs to recognize prices and costs that will be influenced by the inflation rate which country the project is situated.

3) When manager are calculate the corporate profit manager has to use corporation tax which is estimate in country.

4) When manager will be calculate the NPV manager has to use as opportunity cost of capital the rate.

Risk-free bond which exist in the country. It is the some as the rate on U.S. treasury securities. In the end, manager should remember that the principals of valuation of capital investment are the same worldwide.

3.19. (Step 6) Performance and agency problems

In previous parts of this research I have concentrated on criteria and procedures for identifying cross-border contracts with positive NPVs. If a company takes only positive-NPV contracts, it maximizes the company’s value. How could be know that the firm’s managers have the same aim to maximize value? The junior and middle managers have his own interests with outside senior and top managers. How do top managers ensure that middle managers and employees try as hard they can to find positive-NPV contracts? Owners (shareholders) are the ultimate principals for top managers and top managers are the agent s. But middle managers and employees are in turn agents of top managers. Thus senior managers are simultaneously agents of owners and principals the rest of the firm. The problem is to get everyone working together to maximize value and control it. I create the roadmap of performance measurement (Figure 4.1) system which is help corporation to identify and commit the positive-NPV contracts.

Figure 4.1

The main problems of performance measurement are as follows:

• Process: How a company organizes and plans the firm’s portfolio of contracts, how they authorize specific contract, and how they check whether contracts perform as promised.

• Information: Collecting proper information, make good forecasts to decision makers.

• Incentives: To make sure managers and employees are rewarded appropriately when they add value to the firm.

• Performance measurement: It can not reward value added unless managers can measure it. Since manager get what to reward, and reward what was measured. Manager has to make sure that it was measured as the right thing.

My research has a narrow aim that is why I will be have a good look only the performance measurement problems.