Publication Year
Article Type

The Relevance of Classic Valuation Indicators in European Project Funding Requirements


Citation Download PDF

Contemporary Journal of Economics and Finance

Volume 1, Issue 1, December 2022, pages 7-13

The Relevance of Classic Valuation Indicators in European Project Funding Requirements – the Case of Grant “Performance and Excellence in the Field of Environment and Renewable Energy through Modern Cluster Entities”


Albu Delia1, Avram Greti1, Dondera Anamaria1, Dondera Octavian1, Ion Peres1, Diana Cozmiuc1

Faculty of Economics Sciences, Ioan Slavici University, Timisoara, Romania

 Abstract: The classic form of valuation is the Net Present Value of Discounted Cash Flow, which needs to exceed zero. This originates in the Capital Asset Pricing Model and is authored by Treynor (1961, 1962), Sharpe (1964), Lintner (1965) and Mossin (1966) independently of each other. The theory was awarded Nobel Prize for Economics and is regarded as the staple in valuation since. Valuation overarches operational decisions, investment decisions and financing decisions. The formula is typically consistent with IAS 7 Statement of Cash Flow. The reference business to be valued and reported financially is repetitive manufacturing or operations. However project business, like research and development before manufacturing execution, or constructions are also considered in construction projects or valuation. The goal of this article is to analyze the value of the net present value of discounted cash flow and its drivers. The article purposes to enrich the knowledge about European project funding and their requirements. The methodology is a multiple case study on European projects. The case study is descriptive, analytical and instrumental. Findings show discounted cash flow remains the classic reference in valuation and capital allocation. Empirical data shows situations where, using Economic Value Added, data is easy to input directly from the ledgers. Ratio analysis is enabled in greater debt. Furthermore, it has been possible to argue against the suitability of Net Present Value of Discounted Cash Flow due to financing merely a part of the project lifetime as opposed to the original model.

Keywords: net present value of discounted cash flow, IAS7, direct method, indirect method, internal rate of return, economic value added, payback period, return on capital, hurdle rate, certain environment, business plan

1. Introduction

This article analyzes classic value indicators, the Net Present Value of Discounted Cash Flow and the Internal Rate of Return, from the perspective of their staple functionality and New Economy updates. The chapter deals with the formula to compute the Net Present Value of Discounted Cash Flow and the Internal Rate of Return from a financial and business perspective.

The financial perspective tackles the following topics: the Capital Asset Pricing Model; the IFRS standards particularly IAS 7 Statement of Cash Flows; forecasting methods; company valuation; Economic Value Added; Market Value Added. The business decision tackles business planning to derive the financial data that makes up the financial forecast. An aim of this research is to analyze classic valuation on a real life example from today’s practice, which is the grant “Performance and excellence in the field of environment and renewable energy through modern cluster entities”, SMIS number 138692, funded by the Romanian Ministry of Research, Innovation and Digitisation through the Operational Competitiveness Program (POC). This is consistent with the goal of the research, to expound, analyze and exemplify classic valuation and its application in European projects. The research methodology is a descriptive case study. The case subject is the referred to European project. The ground of choosing this methodology is to enable stakeholders understand European projects and the requirements to obtain related funding. Findings show that the classic valuation methodology is used as such. Literature review and empirical data show that several disciplines are involved in valuation, but they are referred to as individual disciplines and an interdisciplinary approach is missing. Empirical data also shows that several documents are required to support the business and financial plan, and they need to be consistent with each other without much explanation as to why and how this could be done. A need for an interdisciplinary approach that ties business planning to financial planning arises. Literature review shows this has been the preoccupation of management advisors on valuation, who are typically management consultants with high practical experience.

2. Individual’s Financial Well-Being

The staple in financial management theory is the Capital Asset Pricing Model CAPM (Black, 1972; Black and Scholes, 1972; Fama, 1968; Fama and French, 2004; Lintner, 1965; Markowitz, 1999; Mehrling, 2005; Mossin, 1966; Mullins, 1982; Ross, 1977; Stone, 1970). This model The CAPM was introduced by Treynor (1961, 1962), Sharpe (1964), Lintner (1965) and Mossin (1966) independently, building on the earlier work of Markowitz on diversification and modern portfolio theory. Sharpe, Markowitz and Miller jointly received the 1990 Nobel Memorial Prize in Economics for this contribution to the field of financial economics. The model classifies assets by their degree of risk, ranging from risk free to high risk (Ross, 1966; Lintner, 1965). CAPM is generally used to classify industries, meaning each industry has its reference risk that is computed by financial analysts. Furthermore the financial model poses that investors expect a rate of return that is proportional to the inherent risk of the industry they invest in. the formula to compute the expected rate of return is:

where the formula defines the expected return on the capital asset. This is calculated by the risk-free rate of interest such as interest arising from government bonds; the beta, which is the sensitivity of the expected excess asset returns to the expected excess market returns; the market premium, that is the difference between the expected market rate of return and the risk-free rate of return. The market premium is also known as the risk premium and it denotes the correlation coefficient between the investment   and the market; marks the standard deviation for the market and for the investment. The expected rate of return weighs in the cost of debt, which is the risk free rate of return, and the cost of equity, which is computed based on specified formula.

CAPM refers to debt and equity as the two forms of capital considered in the formula. CAPM defines the weighted average cost of capital as the cost of equity and debt weighted with their share in company capital. The formula is as follows:

The Weighted Average Cost of Capital is made up of the share of debt and equity in proportion to total capital and the cost of capital which is a percentage ratio. This cost is an opportunity cost, meaning this is the level of return on capital which investors expect. In the CAPM thinking, this becomes a hurdle rate used to accept projects by. The hurdle rate projects must exceed: the cost of capital assessed by the type of capital the project uses becomes the minimum rate of return allowed by the project. On capital markets, valuation experts define this hurdle rate based on the reference cost of debt and equity. Such reports are publicly available on the New York stock exchange by valuation experts such as Damodaran (2004, 2007a, 2007b, 2010, 2012a, 2012b, 2014a, 2014b). Valuation is intended to weigh in the weighted average cos of capital as the hurdle rate for the project or company to be valued.

CAPM is he inspiration for the formula used to value companies and their comprising units. The Sharpe formula computes the net present value of discounted cash flow by applying a discount factor to the cash flow which is summed up on a yearly basis for the prognosis period which is intended as the foreseeable future considering all factors. The decision assumes the future can be predicted in one scenario. Finance questions the timeframe to foresee the net present value of discounted cash flow, using an annuity factor for a chosen timeframe and then a perpetuity. It is an object of research to see how timeframe to compute the annuity and perpetuity in. The discount factor is chosen as the weighted average cost of capital employed or invested. It is only by using this discount factor that it becomes possible to compute the hurdle rate later on.

The net present value of the discounted cash flow is consistent with IAS7 Statement of Cash Flow, consistent with all definitions in the accounting standards. The statement cumulates income, expenditure, assets and liabilities. There are two methods to compute cash flow, the direct method and the indirect method. Both methods are considered in the accounting standard. Both methods explain the variance in cash and cash equivalents in the balance sheet between two accounting periods that are considered, the current accounting period and the previous accounting period. The Statement of Cash flows offsets all accounts in the IAS1  presentation of published financial statements and thereby uses data from the statement of financial position, statement of profit or loss and other comprehensive income, statement of changes in equity. The direct method adds cash inflow to cash outflow without specifying the source of the elements considered. The indirect method mentions analytically which ledgers lead to cash depending on their relation to operational, investment or financial activities. In another terminology, cash inflow is called receipt and cash outflow is called payment. The overall result gives cash flow.

The basic definition in accounting standards refer to the ability to generate future cash flow or economic benefits. These definitions underpin internationally accepted accounting standards and the staple definitions of their elements. Assets are defined as resources controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity. When a company increases assets out of operational or investment activities, it outflows cash. When a company disposes of assets, cash is inflown, regardless of the nature of the activity: operational, investment, financing. Liabilities are a present obligation of the entity arising from past events, the deducting is the residual interest in the entity after deducting all its liabilities. Increases in liabilities are cash inflow, whereas decreases of liabilities are cash outflow. Profit is the residual income after deducting expenditure from income. Income is defined as increases in economic benefits during the accounting period in the form of inflows or enhancement of assets or decreases in liabilities resulting in equity, other than those relating to contributions from equity participants. Expenses are decreases in economic benefits during the accounting period in the forms of outflows or depletion of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Profit may be operational, financing or exceptional. Cash accounting is the oldest, basic and staple method of accounting. However, financial statements are based on accrual concepts, where accruals are reported as liabilities in the balance sheet or as depreciation in the statement of income. Computing cash flow needs to reverse the impact of accruals. Considering these definitions one can compute and understand the indirect formula of cash flow, which adds operating, investment and financial cash flow. Operating activities are the principal revenue producing activities of the entity and other activities that are not investment or financing activities. Operational cash flow is defined by operational residual income free from accrual accounting and considering the movements in current assets and current liabilities. Investment activities are the acquisitions or disposals of non-current assets and other investments not included in cash and cash equivalents. Investment cash flow refers to the movements in fixed assets, may they be additions (cash outflow) or disposals (cash inflow). Changes in the size and the distribution of the contributed equity capital and borrowings of the entity. These may be: cash proceeds from issuing shares; cash payments to owners to acquire or redeem the company’s shares; cash proceeds from issuing debentures, loans, notes, bonds, mortgages, and other short or long-term borrowings; principal repayments of amounts borrowed under finance leases. The statement of cash flows explains the movements in cash and cash equivalents in the current period versus the previous accounting period.

The net present value of discounted cash flow sees the cash flow statement as per defined in the international accounting standards and discounts cash flow with annuities where they are predictable and perpetuities at the last stage of forecasting. In valuation, this method may be called Shareholder Value Added (Rappaport, 1986) and is equivalent to the net present value of discounted cash flow with one add-on: cash flow can be foreseen only when competitive advantage is assured. This method argues cash flow can only be generated when a company holds competitive advantage, after which its capability to earn cash will be washed off.

Project valuation uses the net discounted value of cash flow to compute the Internal Rate or Return IRR. The IRR formula is as follows:

The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero. In other words, it is the expected compound annual rate of return that will be earned on a project or investment. The IRR will be compared to the hurdle rate for investors to be interested, which is the weighted average cost of investment.

Payback period is defined as the number of years required to recover the original cash investment. In other words, it is the period of time at the end of which a machine, facility, or other investment has produced sufficient net revenue to recover its investment costs. Payback period may be computed by dividing the initial cash outlay of a project by the amount of net cash inflow that the project generates each year.

Value indicators net present value of discounted cash flow, internal rate of return, and payback period are used as incremental cash flow to any decision (Damodaran, 2004, 2007a, 2007b, 2010, 2012a, 2012b, 2014a, 2014b). In financial terms, decisions are defined as cash inflow or outflow and their net result. Value indicators are used to value companies, business units, projects, and fixed assets: tangible and intangible. Valuation overspans operational, investment and financial decisions. Investment appraisal may be called capital budgeting. The typical theoretical example is investing in tangible assets. It becomes more complicated to invest in intangible assets, for instance in research and development projects. Other projects: construction projects, software writing are valued in a similar manner. Company valuation is a little bit more complex, and yet entails the net discounted cash flow technique just the same.

Whatever the object of valuations, decisions are made the same way: net present value of discounted cash flow is computed. Based on it, so are internal rate of return and payback period. Hurdle rates for all projects are that the net present value of discounted cash flow exceeds zero and that the internal rate of return exceeds weighted average cost of capital. Otherwise investment is not allowed. Next, projects will be arranged in decreasing order by their highest value until the amount of invested capital available is exhausted. If high value earning projects still exist, new share emissions may be organized to fund them.

In 1986, Rappaport has created the Shareholder Value Added indicator, which oversees valuation for the duration of competitive advantage, after which the future stops being predictable. In valuation, the main decisions are operational, investment and financing. The decisions are made together during the valuation process.


Figure 1: Value driver tree of Shareholder Value Added

In creating shareholder value, competitive advantage gives the value growth duration. This is the timeframe during which cash flow may be forecast. At the end of competitive advantage, value growth cannot be ascertained anymore. The theory assumes value can only be created when competitive advantage exists, and outside competitive advantage there are no predicable cash flows.

Operational decisions involve other value drivers, which are mainly the sales growth rate, the operating profit margin, and the income tax rate. Cash flow from operations may be generated by sales growth, which may require new products, new business units, new companies. The operating profit margin is assessed to be driven by efficiency measures to ensure the same sales generate higher profit. The income tax rate is typically decided by authorities, but may fall in the scope of company decision makers.  Operational decisions impact cash flow from operating activities.

Investment decisions involve investment value drivers, that is investment in fixed assets and investment in working capital. Dated 1986, the SVA model does not account for intangible assets and their particularities. Fixed assets typically refer to tangible assets. Investment decisions impact cash flow from operations via cash flow from investment activities.

The sum of cash flow from operating activities and cash flow from investment activities is cash flow from operations.

Financing decisions and value drivers refer to the cost of capital – that is, the weighted average cost of capital. The weighted cost of capital is the discount rate in the Shareholder Value Added formula. Whereas the cost of equity and cost of debt is a capital market issue, their proportions in the weighted average cost of capital are management decisions. There are several strategies here, as debt is cheaper but more stringent to be reimbursed. Only shareholders assume the risk of ownership, that is, not being reimbursed for their invested capital.

Years 1990 have seen the quest for other value indicators, with proposals such as Economic Value Added, Market Value Added, Total Shareholder Returns, Cash Flow Return on Investment. Of these indicators, economic value added is the numerical equivalent of the net present value of discounted cash flow – an issue proponents Stern, Stewart have argued in their proposal; an issue Professor Damodaran (2004, 2007a, 2007b, 2010, 2012a, 2012b, 2014a, 2014b) scientifically demonstrates; an issue valuation experts at Mc Kinsey (1990, 1994, 2000, 2005, 2010, 2010b, 2015) also agree on. Economic value added (Chew, 1998) is computed as the spread between return on capital employed or invested and the weighted average cost of capital employed or invested and the net capital employed defined operationally (all assets less all current liabilities). Economic value added is also computed as the spread between NOPAT,  that is net operating profit after taxes, and the capital charge, being the weighted average cost of capital times net capital employed. Economic value added needs to exceed zero for value to be created, otherwise value is destroyed. The sum of economic value added over the value growth duration gives market value added. This shows how much value the company creates above the book value of total assets. Value creation may also be reflected in the ratio of market value above the book value of total assets. When the ratio exceeds one, value is created and the business makes sense. EVA is more eloquent, as it summarizes the income statement and the net capital employed on the balance sheet. These financial statements facilitate value driver tee analysis, for example in relation to sales. EVA is positive when return on capital exceeds the hurdle rate, a characteristic which ties the indicator to the Capital Asset Pricing Model showing the value creating businesses which create more value than the opportunity cost of capital.

The net present value of discounted cash flow and economic value added explain the intrinsic value of shares on perfect capital markets. Market imperfections and the strategies to mitigate them sum up to the value indicator total shareholder returns, which is the spread between the value of shares in the reporting period and in the current period to which dividends are added. Shareholders earn from share price increase and dividends. Several analyses about the external and internal environment are conducted in an outside in approach to competitive positioning. This analysis should allow companies to choose a market position that gives sustainable competitive advantage. This is ascertained to generate economic profit. More advanced valuation experts Madden (2010) and Damodaran (2004, 2007a, 2007b, 2010, 2012a, 2012b, 2014a, 2014b) tie value creation in the spread model to competitive advantage. Competitive advantage depends, in their view, on industry structure and lifecycle. Mature industries have similar characteristics between competitive forces, an issue called commoditization which means sources of distinctiveness hardly exist and companies financial results are ascertained to end to the weighted average cost of capital, according to decades long quantitative studies by valuators. Industries at early stages of lifecycle offer possibilities for distinctiveness and thereby competitive advantage. Their return on capital may differ from the market reference value. These studies recommend market analysis as the way to conduct financial forecasts, including economic profit and its synonymous indicators.

Economic value added may be called economic profit, which is noted the most valuable contribution of the industry structure analysis of the Harvard Business School (Ghemawat, 2002). The millennium has seen a new type of assets, intangible assets, emerge and come to explain the logic of value creation. Intangible assets are defined in the related accounting standard, IAS 38, as: patented technology, computer software, databases and trade secrets trademarks, trade dress, newspaper mastheads, internet domains video and audiovisual material (e.g. motion pictures, television programs) customer lists mortgage servicing rights licensing, royalty and standstill agreements import quotas franchise agreements customer and supplier relationships (including customer lists) marketing rights. Intangible assets may be defined as capital: human capital, knowledge capital, relationship capital. Valuation experts like Madden (2010), Daum (2002, 2004), Stegmann (2009) note that almost all economic value created on capital markets since the 1980s gradually increases from tangible assets to intangible assets by the 2000s, and remains steady there in the contemporary business environment. The issue has been whether to expend or capitalize intangible assets. In the Economic Value Added (Young, 2000; Young and O’Byrne, 2000) perspective, some intangible assets, like research and development costs and capitalized rather than expended in order to facilitate funding them from capital rather than yearly sales. The balance sheet equation is that total assets = total liabilities + total equity. When research and development and other pre-operational project or program activities are capitalized, it is possible to fund them from capital sources and raise the necessary funding. However, financial accounting allows capitalization in scarce circumstances. This makes research and development financed as percentage of sales, which means it is allocated temporary and volatile resources rather than permanent resources. Major valuation experts Stern and Stewart (Stern, 2011; Stern, Stewart, and Chew, 1995; Stern, Shiely, and Ross, 2002, 2003; Stern and Chew, 2003; Stewart, 1991, 1994, 2003, 2009, 2013), Chew (1998), Madden (2010) and Damodaran (2004, 2007a, 2007b, 2010, 2012a, 2012b, 2014a, 2014b) argue against this error strongly.

On the other side, IAS 38 uses the maturity stages of research and development to argue that predicting probable future benefits is not possible in the early stages of such activities. Generally speaking, assets are recognized when it is probable they will generate future economic benefits and when they can be controlled by the entity. Intangible assets challenge this definition, as they are marked by innovation, high uncertainty and multi-stakeholder ownership. This makes the assets difficult to be recognized by accepted financial accounting standards. Much of the part of intangible assets is not reported on the balance sheet (Lev 2001, 2002a, 2002b; Lev and Daum, 2004; Lev and Gu, 2012).

Whereas the SVA model has had its own value driver tree analysis, Kaplan and Norton’s strategy map model (Kaplan and Norton, 2004) focuses on shareholder value and four types of drivers: leaning and growth perspective; internal perspective; customer perspective; financial perspective. The learning and growth perspective contains the capitals: human capital, organizational capital and information capital that underpin value creation. The internal perspective looks at activities: operations management processes; customer management processes; innovation processes; regulatory and social processes. These generate customer value in the customer perspective, which may be measured by the following indicators: price, quality, availability, satisfaction, functionality, service, partnership, brand. The financial perspective allows for several financial strategies: improve cost structure; increase asset utilization; expand value opportunities; enhance customer value.


Figure 2: Strategy maps (Kaplan and Norton, 2004)

Whereas valuation is focused on the lifetime of investment, it may be that some funds only reimburse some investment, for instance some forms of development cost. Project management standards from the Project Management Institute or Prince define projects as a one-off effort that preceeds and shapes operations. If can be inferred that investment activities are managed as projects and shape future operations. Recent accounting manuals such as Kaplan’s notes the large part of operational value drivers are decided in the projects that preceed operations, in a technique called lifecycle costing. This means the sales price, the material content, the material price, the operations sequence, the conversion costs, part of the overheads are shaped and decided in the projects that preceed operations.

Financial accounting uses repetitive manufacturing as reference. However, not all business types are repetitive manufacturing or operations. According to IAS 18 Revenue Recognition, repetitive manufacturing is to be complemented by rendering of services or receiving interest. IAS 11 Construction Contracts refers to the projects that build large assets and last long. IFRS15 replaces these standards and allows for more possibilities to recognize revenue on contracts. The distinction between projects that build large assets and operations remains pertinent. It can be inferred cash flow forecasts are different for project business than for operations, and valuation needs to consider the particularities inherent to the business type.

Business cases are the tool to argue investment. Business cases tend to contain market analyses and business plans. Market analyzes have been addressed before. Business plans contain the forecast of net present value of discounted cash flow and goals, objectives, milestones, other project planning elements. Whereas the classic view on strategy and valuation refers to a certain environment, new management tools tackle scenario planning and real options valuation, funding by business models via risk capital or venture capital in lean start-ups, multistakeholder value.

3. Methodology

A descriptive, analytical and instrumental case study is deployed on European project “Performance and excellence in the field of environment and renewable energy through modern cluster entities”, SMIS number 138692, funded by the Romanian Ministry of Research, Innovation and Digitisation through the Operational Competitiveness Program (POC). The empirical data in the case study comes from this project. The case describes and analyzes the activities pertinent valuation in a certain environment, as they have been subjected in the funding request. The focus of the case study are European project requirements, meaning the documents required by the European funding agency to approve the project. The instrumental nature of the case study comes from its utility to other projects.

4. Empirical Data Analysis

The European Union allocates public funds via several types of programs that may be available on EU basis or on national basis. One of these project calls is POC/62/1/3 Stimulating the enterprise demand for innovation via research, development and innovation projects or in partnership with research and development institutes and universities, to the goal of product or process innovation in the economic sectors with high growth potential. A project has been awarded, innovation and economic and functional optimization in the energy production for thermal energy materials. The project has been financed using the net present value of discounted cash flow and internal rate or return. The European Union has offered a file to compute these indicators, based on operational, investment and financial cash flow. The file is matched to the accounts in the Romanian chart of accounts that follow IFRS rule and are classified by each type of activitiy. The file takes into account the major impacts in cash flow and checks that the cash and cash equivalents balance matches the account movements reflected in the statement of cash flow. The goal of the file is to estimate the total cash and cash equivalents created for the company by the end of the period.

The project is a construction which will act as a start-up incubator in the field of renewable energy. The construction will host office space, conference rooms, other type of rooms designed to promote renewable energy and its vendors. Whereas the costs refer to the building itself and have several sources of financing, the income comes from using this space for business activities in several scenarios.

In order to have the construction, the first activitity has been financing cash inflow, in the form of equity from the capital providers. This has created cash flow inflow from financing activities, the starting point of the construction project.

Next, this income has been used for cash outflow from investing activities, mainly: tangible assets; intangible assets; experts and other services. The cash outflow from investment activities has been achieved at the beginning of the forecast period.

Equity has been matched with the fixed assets invested in, meaning equity covers all investment in the first three years fully. Equity has been used to finance the fixed assets invested in.

These activities should achieve the building in a timeframe of three years. The following years offset income from rent, royalties and similar with expenses needed to operate the start-up incubator which the building will be. The following are service types which are to be offered by the start-up incubator:

– the development of databases with information on research – development – innovation (CDI) offers and the demand in the field from the economic environment, the portfolio of patents and licenses of the CI centers, the existing facilities in research-demonstration-trial laboratories that can be marketed;

– inventory/monitoring of research works developed in the fields of ITT completed with technologies, patents, products, prototypes, experimental models; the evaluation and selection of technologies with the potential of capitalization through technological transfer and the creation of a specialized database;

–  dissemination of information regarding local, regional and national priorities in the fields of interest targeted by ITT;

–  the permanent identification of national and international scientific events to ensure the increase in the visibility of scientific potential and results;

–    dissemination of legislation regarding industrial property rights

–   elaboration of analyses, studies, market research, forecasts on topics related to RDI or technology transfer at the request of the private sector;

–   organizing and participating in events to raise awareness of innovation such as fairs, conferences, study visits, meetings between actors in the field (companies and research organizations);

–    providing support to innovative SMEs for the recruitment of qualified personnel; placement of students and those in vocational education in the business environment; technological investment studies;

–     providing business assistance for innovation and technology transfer

The income from these activities will generate the cash inflows. The building intends to be a start-up incubator for renewable energy, and will generate income from the following sources: income from royalty payments, as a result of technology transfer; income from consulting and specialty technical assistance; income from renting office space or conference rooms; income from renting technology equipment; income from transferring and exploiting intellectual property rights; other operational income. As the rooms to be rented or otherwise used will be rented on a repetitive basis involving identical or similar activities, renting the office space has been treated as ongoing operations.

Expenses needed to operate the start-up incubator include: salaries, consulting and social insurance; expenditure on materials and tools; utility costs; maintenance; administrative expenses; other operational expenses. These sources of income and expenditure refer to operational income and give operational cash flow. The financial forecast assumes zero working capital and chances to working capital to be reflected in cash flow.

In summary, the start-up incubator begins with financing cash inflow, which is consumed by investment activities cash outflow. After three years this creates a building space for a start-up incubator for scientific research in renewable energy and related activities, which are repetitive and rated as operations. Whereas equity covers assets in full plus a safety margin, once operating activities begin, cash inflows for the duration of the project. This creates cash and cash equivalents at the end of each reporting period, and the positive nature of these cash and cash equivalents is measured by European funds.

European funds finance enterprises for free. This means the discount factor does not exist, as the cost of capital is zero. The Internal rate of return is not calculated. It makes little sense to compute economic value added or other value indicators of relevance to companies.

One may consider the argument European funds may be compared in terms of return on investment. Whereas net present value of discounted cash flow is the only indicator for investment valuation, other strategic criteria are considered in the form of creating start-up ecosystems; incentivizing innovation and technological transfer; innovating in terms of renewable energy.

There is general agreement that citizens who make sound financial decisions and interact effectively with financial services providers stand a chance to achieve their financial goals and therefore improve their household’s welfare (Perotti et al., 2013). Besides, financially included citizens contribute to financial sector development, which relates positively to economic growth (Kubicková, Nulicek, and Jindrichovska, 2019). Incidentally, these are the twin objectives of financial capability initiatives. It is essential to reflect on the concept of financial capability, which has two-dimension, financial literacy, and access. Several definitions have been offered for financial capability. The UK Treasury (2007), for example, conceptualizes it as a person’s ability to manage money well, both day to day and through significant life events, including periods of financial difficulty. It is influenced by personal skills, knowledge, attitudes, and motivations and made possible by an inclusive financial system and supportive social environment. While Miller et al. (2014) differentiate the two terminologies by suggesting that financial literacy reflects the increase in consumers’ financial knowledge, while financial capability reflects skills, attitudes, and behavior change. Financial literacy is understood as the outcome of sharing information. Johnson and Sherraden (2007) argue that financial literacy is helpful but insufficient for developing financial capability. In reference to the capability theory, people should be enabled to maximize life chances by fully participating and leading economically rewarding lives (Sen, 1993). This approach implies the availability of adequate opportunities for people to engage in desired activities and develop behaviors to become who they want to be (Robeyns, 2005). Distinct from the human capital theory, the capability approach to financial literacy is not purely individualistic. Instead, it takes into account the external environment and array of opportunities open to a person, as well as that person’s internal capabilities. The capability approach requires acquiring knowledge, competencies, and the ability to act on that financial knowledge and an opportunity to perform, which is financial capability.  Vyvyan et al. (2014) suggest that financial capability has two broad themes: acquisition of financial knowledge and skills, which represents financial literacy, and removal of institutional barriers to enhance financial inclusion, access to financial services.  OECD (2005) comprehensively provides an understanding of financial education as consumers’ understanding of financial products and concepts and, through information, instruction, and objective advice, the development of skills and confidence to deal with financial risks and opportunities, make informed choices, and ultimately know where to go for help.  Further following Financial Services Authority (FSA) survey in Taylor (2011), this study explicitly identifies five domains of financial capability in Britain that contribute to financial capability: making ends meet, managing money, planning, choosing products, and staying informed.

5. Conclusion

Net Present Value of Discounted Cash Flow remains the classic indicator in valuation. Literature review shows that all main definitions in financial accounting are related to cash flow generation. Moreover, accounting in terms of cash is older than accounting on accrual basis. All elements of IAS7 Statement of Cash Flows are required to compute the formula. The net present value of discounted cash flow is tied to the Capital Asset Pricing Model via the discount factor. This means the IRR computed based on the net present value of discounted cash flow has to meet a hurdle rate, the weighted average cost of capital employed – which is zero for European funds.


  • Black, F., and Scholes, M. (1972). The Capital Asset Pricing Model: Some Empirical Tests, pp. 79–121 In Jensen, M., E., Studies in the Theory of Capital Markets, Praeger Publishers, New York, USA
  • Black, F (1972). Capital Market Equilibrium with Restricted Borrowing, Journal of Business, 45 (3), pp. 444–455; doi:10.1086/295472
  • Chew, D. (1998). Discussing the Revolution in Corporate Finance, New Jersey, USA
  • Damodaran, A. (2004). Investment Fables: Exploring the Myths of ‘Can’t Miss’ Investment Strategies, Financial Times Press
  • Damodaran, A. (2007a). Strategic Risk Taking: a Framework for Strategic Management, Pearson Prentice Hall 315
  • Damodaran, A. (2007b). Return on Capital (ROC). Return on Invested Capital (ROIC). and Return on Equity (ROE): Measurement and Implications, New York University, Stern School of Business
  • Damodaran, A. (2010). Applied Corporate Finance, Wiley, New Jersey, USA
  • Damodaran, A. (2011). Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, Wiley, New Jersey, USA
  • Damodaran, A. (2012a). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, Wiley, New Jersey, USA
  • Damodaran, A. (2012b). Investment Philosophies: Successful Strategies and the Investors Who Make Them Work, Wiley, New Jersey, USA
  • Damodaran, A. (2014a). Economic Value Added (EVA), Retrieved on August 20th, 2022, from: http://people.stern.nyu.edu/adamodar/New_Home_Page/lectures/eva.html 
  • Damodaran, A. (2014b). Value Enhancement: EVA and CFROI, Retrieved on August 20th, 2022, from: http://people.stern.nyu.edu/adamodar/pdfiles/eqnotes/eva.pdf
  • Daum J., H. (2002). Intangible Assets oder die Kunst Mehrwert zu schaffen, Galileo-Press, Bonn, Germany
  • Daum, J.. H. (2003). Intangible Assets and Value Creation, Wiley, New Jersey, USA
  • Fama, E., F. (1968). Risk, Return and Equilibrium: Some Clarifying Comments, Journal of Finance, 23 (1), pp. 29–40; doi:10.1111/j.1540-6261.1968.tb02996.x.
  • Fama, E., F., and French, K. (1992). The Cross-Section of Expected Stock Returns, Journal of Finance, 47 (2), pp. 427–466; doi:10.1111/j.1540-6261.1992.tb04398.x
  • Fama, E., F., and French, K., R (2004). The Capital Asset Pricing Model: Theory and Evidence, Journal of Economic Perspectives, 18 (3), pp. 25–46; doi:10.1257/0895330042162430
  • Ghemawat, P. (2002). Competition and Business Strategy in Historical Perspective, Business History Review, Spring 2002; 76 (1); ABI/INFORM Global
  • Lev, B. (2001). Intangibles: Management, Measurement, and Reporting, Bookings Institution Press, Washington, USA
  • Lev, B. (2002a). Intangibles at Cross-Roads: What-s Next?, Financial Executive Magazine, March/ April
  • Lev, B. (2002b). The Importance of Organizaţional Infrastructure, Financial Executive Magazine, July/ August
  • Lev, B., and Daum, J. (2004). The Dominance of Intangible Assets: Consequences for Enterprise Management and Corporate Reporting, Emerald
  • Lev, B., and Gu, F. (2016). The End of and the Path Forward for Investors and Managers, Wiley, New Jersey, USA
  • Lintner, J. (1965). The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets, Review of Economics and Statistics, 47 (1), pp. 13–37; doi:10.2307/1924119. JSTOR 1924119
  • Markowitz, H., M. (1999). The Early History of Portfolio Theory: 1600–1960, Financial Analysts Journal, 55 (4), pp. 5–16; doi:10.2469/faj.v55.n4.2281
  • Mehrling, P. (2005). Fischer Black and the Revolutionary Idea of Finance, John Wiley & Sons, New Jersey, USA
  • Mc Kinsey (1990). Valuation: Measuring and Managing the Value of Companies, John Wiley & Sons, New Jersey, USA
  • Mc Kinsey (1994). Valuation: Measuring and Managing the Value of Companies, John Wiley & Sons, New Jersey, USA
  • Mc Kinsey (2000). Valuation: Measuring and Managing the Value of Companies, John Wiley & Sons, New Jersey, USA
  • Mc Kinsey (2005). Valuation: Measuring and Managing the Value of Companies, John Wiley & Sons, New Jersey, USA
  • Mc Kinsey (2010). The Four Cornerstones of Corporate Finance, John Wiley & Sons, New Jersey, USA
  • Mc Kinsey (2010b). Valuation: Measuring and Managing the Value of Companies, John Wiley & Sons, New Jersey, USA
  • Mc Kinsey (2015). Valuation: Measuring and Managing the Value of Companies, John Wiley & Sons, New Jersey, USA
  • Stegmann, P. (2009). Strategic Value Management: Stock Value Creation and the Management of the Firm, Wiley, New Jersey, USA
  • Young, D. (2000). EVA: the Missing Link”, Financial Times Mastering Management, New York, USA
  • Young, D., S., and O’Byrne, S., F. (2000). EVA and Value-Based Management: a Practical Guide to Implementation, Mc Graw Hill, New York, United States
  • Mossin, J. (1966). Equilibrium in a Capital Asset Market, Econometrica, 34 (4). pp. 768–783; doi:10.2307/1910098. JSTOR 1910098
  • Mullins, D., W. (1982). Does the capital asset pricing model work?, Harvard Business Review, pp. 105–113
  • Rappaport, A. (1986). Creating Shareholder Value: A Guide for Managers and Investors, The Free Press, Cambridge, United Kingdom
  • Ross, S., A. (1977). The Capital Asset Pricing Model (CAPM). Short-sale Restrictions and Related Issues, Journal of Finance, 32 (177)
  • Sharpe, W., F. (1964). Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, Journal of Finance, 19 (3). pp. 425–442; doi:10.1111/j.1540-6261.1964.tb02865.x. 
  • Sharpe, W., F. (1966). Mutual Fund Performance, Journal of Business, 39 (S1). pp. 119–138, doi:10.1086/294846.
  • Sharpe, W., F. (1994). The Sharpe Ratio, The Journal of Portfolio Management, 21 (1). pp. 49–58; doi:10.3905/jpm.1994.409501. Retrieved June 12, 2012.
  • Stern, E. (2011). The Value Mindset. Returning to the First Principles of Capitalist Enterprise, Wiley, New Jersey, USA
  • Stern, J., M.; Stewart, G., B., and Chew, D., H. (1995). The EVA Financial Management System, Journal of Applied Corporate Finance
  • Stern, J., M., Stewart, G., B., and Chew, D., H. (1995). The EVA Financial Management System, Journal of Applied Corporate Finance
  • Stern, G. M.; Shiely, J., S., and Ross, J. (2002). The EVA Challenge. Implementing Value-Added in an Organization, Wiley, New Jersey, USA
  • Stern, G., M., Shiely, J., S., and Ross, J. (2003). The EVA Challenge. Implementing Value-Added in an Organization, Wiley, New Jersey, USA
  • Stern, J., M., and Chew, D., H. (2003). The Revolution in Corporate Finance, Wiley, New Jersey, USA
  • Stewart, G., B. (1991). The Quest for Value, Harper Collins, New York, USA
  • Stewart, G., B. (1994). EVA. Fact and Factory, Journal of Applied Corporate Finance
  • Stewart, G., B. (2003). How to Fix Accounting: Measure and Report Economic Profit, Journal of Applied Corporate Finance
  • Stewart, G., B. (2009). EVA Momentum. The Ratio that Tells the Whole Story, Journal of Applied Corporate Finance
  • Stewart, G., B. (2013). Best Practice EVA, Wiley, New Jersey, USA
  • Stone, B., K. (1970). Risk, Return, and Equilibrium: A General Single-Period

Comments are closed.