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Evaluation of Investment Projects & Business Valuation

Module: Module 2 — Functional MasteryCode: EIPBV (PBE)Faculty: Prof. Pradip BanerjeeSessions: 3Status: ✅ Drafted

Big idea​

Prof. Pradeep's pairing covers the two questions every CFO faces: Should we invest in this project? (capital budgeting) and What is this business worth? (business valuation). Both rest on the same engine — discounted cash flow — but they differ in scope: capital budgeting evaluates incremental project cash flows over a defined life; valuation estimates the value of an ongoing business with an explicit forecast period plus a terminal value. The MBA toolkit for capital budgeting is NPV, IRR, Payback, Discounted Payback, PI, and ARR — NPV is theoretically dominant. For valuation there are two complementary lenses: intrinsic (DCF) and relative (market multiples like EV/EBITDA, P/E, EV/Revenue). Good practitioners use both and triangulate.

Key concepts​

  • Cash flow is the unit of analysis. Forecast incremental, after-tax free cash flows: revenue – cash costs – taxes + depreciation – ΔWC – CapEx. Ignore sunk costs; include opportunity costs and side effects on other products.
  • NPV — the gold standard. NPV=∑t=1NCFt(1+r)t−CF0NPV = \sum_{t=1}^{N} \frac{CF_t}{(1+r)^t} - CF_0. Accept if NPV > 0; for mutually exclusive projects, pick the highest NPV. Always preferred to IRR when they disagree.
  • IRR and its traps. The discount rate that sets NPV to zero; accept if IRR > cost of capital. Traps: multiple IRRs with non-conventional cash flows, the reinvestment-rate assumption, and misleading rankings on mutually exclusive projects of different scale.
  • Payback / discounted payback / PI / ARR. Payback is a liquidity screen (ignores time value and post-payback cash); discounted payback fixes time value but still ignores tail cash; PI = PV(inflows)/investment (useful when capital is rationed); ARR uses accounting profit — avoid for accept/reject decisions.
  • Intrinsic valuation (DCF). Explicit forecast period (5–10 years) of free cash flow + terminal value (Gordon growth or exit multiple), discounted at WACC. Subtract net debt to get equity value; divide by shares for value per share.
  • Relative valuation (multiples). EV/EBITDA, EV/Revenue, P/E, P/BV compared to a peer set adjusted for growth, risk, and accounting differences. Multiples are fast but inherit whatever errors are already priced into the comparables.

Self-check​

Two mutually exclusive projects: A has NPV = ₹100 crore, IRR = 25%, scale ₹500 crore. B has NPV = ₹50 crore, IRR = 40%, scale ₹100 crore. The firm's cost of capital is 12% and capital is not rationed. Which should you choose and why?

  • A. B — it has the higher IRR
  • B. A — it adds more absolute value (₹100 crore vs ₹50 crore) to shareholders; IRR is misleading when comparing mutually exclusive projects of different scale
  • C. Cannot decide without payback periods
  • D. Pick the one with shorter horizon
NPV decision rule and why it dominates IRR
Accept if NPV > 0. NPV measures absolute value added; IRR is a percentage. For mutually exclusive projects of different scale or timing, NPV gives the correct answer; IRR can mislead. NPV also handles non-conventional cash flows (multiple sign changes) without the multiple-IRR problem.

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Continue learning​

📖Damodaran · BookInvestment Valuation (Damodaran)Free chapter PDFs of the encyclopaedic working reference — DCF, multiples, real options, and special-case valuations.📄CFI · ReadCFI: Free DCF Model Training GuideStep-by-step DCF build with downloadable Excel — the cleanest applied walk-through for first-time modellers.📖McKinsey · BookValuation (Koller, Goedhart & Wessels)McKinsey's practitioner bible — strongest on terminal-value pitfalls and ROIC-as-value-driver framing.🧰Tool · PractiseScreener.inIndian-equity screening with ready 10-year DCF, multiples and peer-comparison views — the fastest place to triangulate intrinsic vs relative valuation.
🪞 Apply it — reflection prompts
  1. Take a current project proposal on your desk. Compute NPV, IRR, payback and PI. Where do they disagree, and which one are you going to trust for the recommendation — and why?
  2. Pick a listed peer to your firm and pull its current EV/EBITDA on Screener.in. Reconstruct what growth and margin assumptions would justify that multiple via a back-of-envelope DCF.
  3. For one current DCF in use at your firm, audit the terminal value as a % of total enterprise value. If TV is > 75% of EV, what does that say about the explicit forecast period — and the reliability of the answer?

📝 Going deeper. Aswath Damodaran's Investment Valuation (3rd ed., 2012) is the encyclopaedic working reference for both intrinsic and relative valuation; for capital budgeting, Brealey-Myers-Allen chapters on NPV and IRR are the standard. For terminal-value pitfalls, McKinsey's Valuation: Measuring and Managing the Value of Companies is the practitioner bible.