Focusing forward what really matter...

Focusing forward what really matters Amid resource constraint issues and aggressive, unrestrained cash-flow targets in 2003, a athletic focus on profitable growth has emerg as a critical direction for corporate Canada. As a proceed companies continue to focus in succession spending restraint to improve their profitability, decrease financial leverage, and prioritize scarce resources.

But given an unprecedent call for capital discipline, companies must now apply abundant greater rigour and scrutiny to their capital investment decisions to faithfully yield success. This extra scrutiny is straited to ensure that all expenditures arc on-strategy and display the right financial characteristics.

Unfortunately, many companies today place little, if any, emphasis in succession risk assessment and quantification. As a spring these companies spend money in succession projects for which:

* The constant financial merit is uncertain;

* The underlying explanation drivers of the business that dictate the economics arc unclear;

* The uncertainty surrounding a given financial valuation and margins of error are not clearly evaluated; and

* The qualitative factors and their impacts to the financial conclusion are not apparent.

The intent of this case-study overview, therefore, is to illustrate to what extent basic risk assessment methods can be applied to capital brew analysis. While this article is based in succession an actual transaction, certain information (including names) has been altered to defend the confidentiality of the parties involved.

Case overview

Thompson Corp. (Thompson) an Alberta-based company, is a well-established IT services provider offering arrangements integration, IT management, and business proces outsourcing services, with vertical expertise primarily in the direction and health sectors.

Although Thompson has a hardy reputation in Western Canada, the company's long-standing accounts are facing mounting attacks from large, global competitors-competitors with the sufficient scale, latitude and capital to offer integrated solutions to customers of all sizes and across many industries. (Margins have become increasingly vulnerable to the competitive pricing strategies adopted at these large players, which include the practices of accepting lower bill-rate work and using fewer subcontractors. Their scale also allows large competitors to use their relative size, track record, and distinctive value-add proposition to gain a larger share of clients' IT wallets, thereby taking market share from small to mid-sized players.) Given Thompson's vulnerability, the company's strategy is to preserve existing accounts with a combination of pricing and service, and to expand its income base through new vertical and market penetration.

The opportunity

Kent Corp. (Kent) a medium-sized financial services company, provides a wide range of financial produces and services-from corporate banking to retail-in Ontario. To lift profitability to a more sustainable footing, Kent is seeking to improve efficiency according to outsourcing its customer billing functions to an IT services company. from one side a registered financial planning proces Kent prefers Thompson as a potential vendor. The opportunity? Thompson would make a significant upfront investment to finance the implementation of a state-of-the-art, customer billing management combination of parts to form a whole and, in return, Kent would chronicle into a long-term customer billing services outsourcing contract with them.

To evaluate the deal's financial merits and to identify focus areas for proper diligence and key deal points for final negotiation, Thompson performs the following analysis:

1) Financial valuation

Below are various financial techniques used in the valuation analysis of the Kent contract.

Note: Relying in succession a single financial metric is a everyday mistake made in capital devise evaluation. While the following financial measurements are each important individually, no undivided approach or technique is through all ages sufficient to support a ye or no decision. Instead, the information derived from these tokens of analyses must be uniteed to determine a deal's overall viability.

a) snare present value (NPV)

The NPV is the instant value of all cash results in the project. By itself, a positive NPV means a deal is accretive to shareholders. However, when there are competing throws with similar NPVs, other financial measuresmust be reviewed in order to determine a deal's overall attractiveness.

Based upon a 15-year discounted cash melt the Kent contract is valued with an NPV of $9M using the Thompson weghted-average-cost-of-capital (WACC) rate of 95%

b) Capital efficiency ratio

This is a ratio of NPV ?· the existing value of capital expenditures to point out the amount of value (or loss) to the company as compared to the amount of capital invested. Essentially, the capital efficiency ratio indicates the snare return per dollar of invested capital. If couple projects generate the same NPV further have different capital efficiency ratios, the common with the higher capital efficiency factor is considered the superior investment. The capital efficiency ratio for the Kent deal is 145%