Doubts

Chapter 8 Video

Chapter 8 Video

by Salvador Valverde R. Azevedo Almeida -
Number of replies: 2

Hello Professor, I get the explanation of this example in the video, but I can't stop thinking the following: why do we have to account the 800 000€ on the company? Technically, those are already accounted by the addition of the NPV right, because otherwise we'd just account the perpetuity of 120 000€/period of this new investment. I don't know if I' making sense haha. Thanks in advance


In reply to Salvador Valverde R. Azevedo Almeida

Re: Chapter 8 Video

by Alois Jari Thomas Neff -
Hi Salvador,
Here's how I understood it:
- Assets (Aktiva) side of the balance sheet: We invested €800,000 into assets, so this amount needs to be reflected on the assets side of the balance sheet. For example, if we invest €800k in machinery, these will appear as non-current assets on the balance sheet.
- Liabilities/Equity (Passiva) side: For every asset we invest in, we need corresponding capital on the liabilities/equity side of the balance sheet. In this case, the company will finance the investment by issuing new shares worth €800k (asset-equity swap).
- As I understand it, the NPV of €400k refers only to the expected future cash flows from this investment, which would be recognized on the assets side of the balance sheet under current assets. According to the cash flow statement, the €800k outflow from the investment and the expected inflows are already considered. However, this doesn’t mean that the actual value of the acquired non-current asset is reflected yet. It's simply a different perspective (cash flow vs. non-current assets).
Please correct me if I’m wrong.
In reply to Salvador Valverde R. Azevedo Almeida

Re: Chapter 8 Video

by Julio Crego -
Dear Salvador,

There is a difference between market value accounting and accounting. Market value accounting does not exist. It is just a conceptual framework to understand Modigliani Miller.

Having said that, the 800,000 should be in both accountings. Let's go loosely through the normal accounting:

* Issue equity
----> Cash 800,000 [Assets]
----> Equity 800,000
because investors gave cash in exchange of shares

* Invest in the project
------> Machine: 800,000 [Assets]
------> Cash: (-800,000) [Assets]
That's it. The firm has 1.8M Assets and 1.8M Equity

The value accounting is different because it recognizes that the machine will produce a positive NPV. This extra value we add to Assets. Someone has to own that value; therefore, either the value of equity or the value of debt should increase. In this case, we only have equity, so their value must increase since they are the ones getting the cash flows.