The term investment has many definitions, a common theme involves; the commitment of money, time, effort and/or other resources with the expectation of a worthwhile result(s). However, how can an individual and/or a large organisation truly determine if such an investment will result in gaining something deemed ‘worthwhile’?
One way recommended by academics is to consider to time value of money, the use of this can aid in creating shareholder wealth since the cash flows of a project are monitored over a time period. Doing so can help monitor the risk of the project – business, financial and bankruptcy risks, and help in analysing the value of the project against the rate of inflation, without returns being higher than inflation the shareholder will not receive any wealth. This topic can be linked back to my first blog regarding the acquisition made by Sanofi-aventis (SA) on Genzyme. This case involves SA undervaluing Genzyme’s shares; they offered $69 per share when they were operating at $72 per share (BBC News, 2011). A main issue in this deal, which is still continuing, is the drug Lemtrada. The problem involves SA not believing this drug will have the returns that Genzyme believe it will. Trying to resolve this, SA offered a Contingent Rights Value on the drug (The Financial Times), meaning they agreed to future payments if Lemtrada is more successful than originally thought, an attempt by SA to ‘bridge the gap’ between the views of the companies.
Not knowing whether SA contemplated other options, but using Internal Rate of Return (IRR) on Lemtrada to truly see if it is likely to bring about the returns expected by either company. Secondly, Net Present Value (NPV) could be calculated on the acquisition of Genzyme could maybe see if the deal would bring about a positive return. The use of IRR can be easier communicated with it showing an actually percentage, making it easier for those who don’t understand appraisal techniques. The calculation of NPV is a strong tool with it having goal congruence with the organisations aim of shareholder wealth, by highlighting the project that will create the most wealth. The calculation results in it either being positive, negative or equal to zero. Generally speaking if the NPV was to be positive it suggests that the project is worth investing in as it will create wealth. A common problem when considering NPV is that it is complex and difficult to understand, but how hard is it when it has been taught and used in the business world for many years. Secondly, it is criticised due to the fact that it is difficult in determining the cash flow and due to them being an estimate can you trust them? – When you think about, is this not the case for all tools similar to NPV? Other issues involve the fact that any project with a positive NPV the company should invest into, obviously only if there is sufficient cash available. Should the company really do this, they need to ensure that there is a synergy between the original company and the project/company they may be working with, merging or acquiring. In the case of SA and Genzyme there is synergies between the two, but it is giving SA the opportunity to diversify into more rare diseases. However, with this not being the case in all ventures, NPV does not take all strategic issues into account, therefore I would suggest to not use NPV blindly.
Realised by academics and other business experts was that you often don’t know what the returns or even the costs would be when calculating things like NPV and IRR. What was suggested was to calculate the probability of the different values occurring, therefore translating uncertainties into hard figures. Again the critics highlight the fact of where did the probabilities come from and argue are we not just substituting one estimate for another? - And making an organisation exposed to possibly losing millions by injecting further subjectivity into their activities and decisions?
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