Optimal Capital Budget
Marginal cost of capital (MCC) plays a very important role in capital budget... Read More
Projects which have a positive NPV should, in theory, increase the value of a company as well as the value of its stock. This could help explain the popularity of NPV as a capital budgeting evaluation method.
Relationship Among NPV, Company Value, and Share Price
If a company invests in a positive NPV project, the expectation is that shareholder wealth as well as the company’s stock value will be increased.
Crudely speaking, the market value of the company would be expected to increase by the NPV amount. The stock price would also be expected to increase by the NPV per share, i.e., the NPV divided by the number of outstanding shares. The effect of a project’s NPV is, however, more complicated than this.
To an analyst, the impact of an investment on a company’s stock price depends on whether or not the profitability of the investment is more or less than expected. For example, a company’s project may have a positive NPV, but if its profitability is less than what analysts expect, then the company’s stock price might fall.
It is worth appreciating that news of a project that has a positive NPV sends a positive signal to the markets, causing market players to expect that other profitable projects could be underway. This may serve to increase the stock price of acompany.
The capital budgeting processes employed by a management may indicate the extent to which the management embraces shareholder wealth maximization and its commitment to the pursuit of that goal. This is extremely important to both shareholders and analysts and may influence company valuation and share price.
Question
What kind of effect is a project with a positive NPV expected to have on the value of a company and its share price?
A. Positive
B. Negative
C. Neutral
Solution
The correct answer is A.
Projects with a positive NPV are theoretically expected to increase the value of a company as well as the value of its stock.
Reading 32 LOS 32g:
Describe expected relations among an investment’s NPV, company value, and share price
Sergio Torrico
2021-07-23
Excelente para el FRM 2
Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé
AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
diana
2021-07-17
So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts.
The fun light-hearted analogies are also a welcome break to some very dry content.
I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
Kriti Dhawan
2021-07-16
A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them.
Thank you ! Grateful I saw this at the right time for my CFA prep.
nikhil kumar
2021-06-28
Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
Marwan
2021-06-22
Great support throughout the course by the team, did not feel neglected
Benjamin anonymous
2021-05-10
I loved using AnalystPrep for FRM.
QBank is huge, videos are great.
Would recommend to a friend
Daniel Glyn
2021-03-24
I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
michael walshe
2021-03-18
Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.