Finance function revising project analysis, but cost of capital practices lag
by Ben Poole
Increasing volatility in product lifecycles is causing finance to shorten the time period analysed for cash flows and demonstrate a preference for non-valuation metrics, according to the 2019 Association for Financial Professionals (AFP) Project Investment Decisions Survey. The survey focuses on the process of project decision-making and how financial planning and analysis (FP&A) departments are savvy business partners that deploy corporate capital effectively.
Comparing data from 2019 with that of 2013, the survey revealed that 41% of respondents analysed less than three years of project investment cash flows, an increase from 11% in 2013. Only 49% reported that they use terminal value (TV) as part of their evaluation, a decrease from 82% in 2013, and 51% of all projects evaluated are 12 months or less in duration.
“The pace of change in the market is so fast - for companies and for products - that FP&A practitioners have changed their evaluation methods to adapt and be more responsive,” said Jim Kaitz, president and CEO of AFP.
Other notable findings from the survey include:
- 60% of companies use five or more financial metrics to evaluate projects, and 27% use 10 or more.
- 38% of companies have adopted agile methodologies, but have not put in place all the mechanisms to become truly agile.
- Operating expense (Opex) projects differ from capital expense (Capex) projects in dollar size, project duration, and the choice of evaluation metrics.
One area that did not change was the cost of capital calculation. According to Professor Aswath Damodaran from New York University’s Stern School of Business, finance departments have some catching up to do. Addressing the survey results about frequency of updates, Damodaran observed, “There is a lot of consistency from 2013 to now, in terms of the calculation methodology and how it was applied, but consistency is not always a good thing because the world has shifted. You’ve got distrust of central banks, government and experts. You’ve got interest rates that are lower than the rates you have faced for close to a century. You’ve got macroeconomic shifts, and people are still doing what they used to do. The constructed cost of capital for a company should never be a constant for the whole year.”
Professor Damodaran recommended practitioners stay agile in re-valuing the project cash flows, the cost of capital, and especially the decisions after they are made. “All the numbers in your project analysis are changing,” he said. “We live in a world of change. To think that change doesn’t happen doesn’t make it go away.”
AFP conducted the survey in September 2019. It generated 622 responses from corporate finance professionals across industries.
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