Sustainable value creation is essential to secure the long-term success of the company. To optimize the allocation of financial resources, we use a defined set of parameters as criteria for prioritizing investment opportunities and portfolio decisions.
Net present value (NPV)
The main criterion for prioritizing investment opportunities is net present value. It is based on the discounted cash flow method and is calculated as the sum of the discounted free cash flows over the duration of a project. The weighted average cost of capital (WACC), representing the weighted average of the cost of equity and cost of debt, is used as the discount rate. Different markups are applied to the WACC depending on the nature and location of the respective project.
Internal rate of return (IRR)
The internal rate of return is a further important criterion for the assessment of acquisition projects and investments in property, plant and equipment, as well as intangible assets. It is the discount rate that makes the present value of all future free cash flows equal to the initial investment or the purchase price of an acquisition. A project adds value if the internal rate of return is higher than the weighted cost of capital including markups.
Return on capital employed (ROCE)
In addition to NPV and IRR, return on capital employed is an important metric for the assessment of investment projects when looking at individual accounting periods. It is calculated as the adjusted operating result pre (EBIT pre) divided by the sum of property, plant and equipment, intangible assets, trade accounts receivable, trade accounts payable, and inventories.
Payback period
An additional parameter for assessing investments in property, plant & equipment, and intangible assets is the payback period, which indicates the time in years after which an investment will generate positive net cash flow.
Merck value added (MEVA)
Merck value added gives information about the financial value created over a period of time. Added value is created when the return on capital employed (ROCE) of the company or the business is higher than the weighted average cost of capital (WACC). MEVA metrics provide us with a powerful tool to weigh investment and spending decisions against capital requirements and investors’ expectations.