Master in Decision Making & Innovation
It has been a pleasure to be your mentor in this project appraisal module. I hope you have enjoyed it as well. I am happy with the overall performance of the group. Most of you have shown interest in the topic, put a lot of effort and made a great job in your activity. Thank you!
This master program is about decision making, so we want you to have all the tools you need to decide if a project is worth doing or not. The project evaluation goal is finding the most efficient way to achieve the project objective with the limited resources we have at our disposal. For this purpose, we have several tools such the ones introduced in the activity.
One project was an infrastructure under a PPP scheme where we needed to evaluate what option was better (cost-efficient) to develop this project. In this case our tool was quantitative value for money to compare the present value of all costs for both options. The other project was investing in a start-up where we needed to evaluate if the company was worth investing (cost-benefit). In this case the tool was the VC method to compare the resources invested with value of the share bought with those resources.
In the Metro Madrid case, most of you did a good job on both theory questions. However, some of you focused on the general concept of VFM and did not apply it to the context of evaluating Public-Private Partnerships (PPP) for infrastructure projects. Remember value for money analysis is a process to assist public sector decision‐makers in order to select the appropriate procurement approach that provides the maximum benefit for society.
When governments think about providing infrastructure to society, they have to determine whether the “best” model for service provision is via public or private delivery. In this context, quantitative VFM computes the present value of the total lifecycle costs incurred by government for different contractual alternatives. The cost of a PPP is compared to an equivalent and usually hypothetical project financed and delivered by the public sector called the public sector comparator (PSC). The VFM is the positive difference or savings between the cost of PPP and the cost of PSC.
The second theory question was about the main components of quantitative VFM for benchmarking both options. Most of you accurately described them. There are different methodologies used across the world to calculate VFM but, as we discussed in the webinar, all of them share some common components: (1) Base Cost; (2) Financing Cost; (3) Retained Risks by the Public Sector; and (4) Competitive Neutrality.
Moving forward I understand the most challenging part of the activity was the practice problems; quantitative VFM in Metro Madrid and the entire case of CardioX. I would like to share with you the solutions for both problems. In the attached documents you can see the excel file with quantitative VFM for Metro Madrid, including the PSC costs, PPP costs, and analysis tab with the final calculations of value for money and a summary graph. Also, in the pdf file you can see all the calculations for CardioX.
In the quantitative VFM for Metro Madrid, most of you completed the exercise correctly. You identified all costs (base, financial, risks and competitive neutrality) for both options and included them accurately in the template. Most common mistakes here are associated with applying inflation to facility management and maintenance costs, the schedule of payments for the financial cost, the calculation of risk retained cost with different percentages during construction and operation, and the application of 3% discount rate to calculate all present values. If you made one these mistakes, I would suggest you take a look at the webinar, attached material, and exercise solutions. Each step is explained in detail.
In the second question, we focused on a young startup company: CardioX. In this case we had to evaluate if it was worth it to invest in this new company. This case revolves around the VC Method. The VC method is the most common valuation strategy used by venture capitalist. The investment recommendation is based on the comparison of the investors’ cost to his benefits. Costs are represented by the dollars invested in the startup and the benefits are represented by the value of the shares (partial valuation).
In order to apply the VC method you need a few key inputs such as the ownership structure and the exit valuation. This is why in question 1 and 2 we focus on those two issues. Otherwise, we would not be able to calculate the VC method in question 3. Question 1 is fairly simple and almost all of you had it right.
First, pre-money valuation is the valuation of a company prior to an investment or financing ($12M) and post-money valuation is the company’s value after outside financing and/or capital injections are added to its balance sheet. Financing was $3M, therefore post-money valuation was $15M. Ownership for investor is 3M/15M= 20%.
Second, the exit value is the expected value of the start-up at the time of the successful exit, where successful exit is considered to be when the investor sale its share of the company a few years after investing in the start-up. One of the methods to calculate the exit value is the multiples method. This method takes into consideration the company together with its peers.
The valuation is a two-steps process. We first identify a set of similar companies, and then analyze a variety of valuation ratios for these companies. We find a set of current companies that are comparable to our company. Comparability is usually established based on similarities in industry and growth potential. We then compute various valuation ratios of these companies.
Most of you did a great job calculating the ratios of table 3. Very simple. If the ratio is EV/EBITDA you had to use the EV value and divided by the EBITDA value. In order to calculate the implicit valuation, we had to use the ratio and multiply it by the EBITDA value of our company. The rationale here is that if a very similar company has a value that is 6.2 times its EBITDA value, our value should also be 6.2 times of OUR EBITDA. Therefore the use the ratio 6.2 as a tool to approximate the value of our company. When we have more than one ratio and more than one company we do an average to arrive to our final valuation.
For those of you that watched the webinar and review the power point presentation it was not difficult to complete this part of the exercise correctly because I provided similar examples and I also highlighted the most common mistakes when applying this tools for the first time. Finally, the last question was the VC method where you had to integrate all the piece of information we had from question 1, question 2, and the data provided in the wording of the case.
Some of you did not calculate correctly questions 1 and 2, therefore the final outcome in question 3 was not accurate, but if you applied the VC method correctly I gave you partial credit in this question. The most common mistake applying the VC method was the calculation of step 3: the multiple. You had to follow the formula provided. Cost of capital was 16%, and Time was 4 years. In the formula remember time is an exponential function and it is not multiplying.
This is all from my side. I hope you enjoyed this activity and find this information useful to complement the personalized feedback I provided to every team. I wish you the best of luck in your future endeavors.
Project Appraisal Expert