Disinvestment/Acquisition

First consider disinvestment, also known as redeployment, or the firm's disposal of a

project. What criteria should be used? The first is to evaluate the property on a point
forward basis. The future cash flow of the project should be determined and discounted
at some hurdle rate. This rate is often set lower than the investment hurdle rate. If the
project has any debt associated with it, that amount should be subtracted from the value.
Likewise, working capital at the time of disposal should be considered. If positive, working
capital could add value. Major items on the accounts should also be evaluated. For
example, some receivables may need to be written off as bad debt. Likewise the value of
spare parts may have increased due to inflation. Short-term debt should not be double-
counted in the debt components. Tax consequences are also very important. Sale of an
asset usually generates taxes, and the amount generated can vary depending on the
nature of the sale transaction. Among items to be considered are depreciation recapture,
ITC recapture, and capital gains taxes. Once the after-tax value of the asset is
determined, a firm has an idea of an acceptable price. However, strategic considerations
are often important and should not be overlooked. If this project has nonquantifiable
synergistic effects with other projects, marketing programs, or another area of the firm's
business, these factors should be weighed in the decision. Mergers or acquisitions are
similar to disinvestment except the firm is the buyer rather than the seller. Again, a
discounted cash flow method is appropriate to determine the value of the asset. Other
performance measures, such as competitive position and market share. can be
ascertained. Factors such as strategic goals and cash availability are also important. A
firm has some flexibility here on how to acquire an asset. Different methods are available
such as stock for stock, stock for assets, etc., and can result in different depreciable bases
for tax books (a real dollar effect). Debt and working capital should again be quantified
from the purchaser's side. Potential liabilities, e.g., pensions, lawsuits, environmental
problems, should also be assessed. Farm-in/farm-out analysis is a form of acquisition/
disinvestment. Payments for purchase or sale occur over time in the form of capital
investments, options, royalties, lump sum amounts, percentages of income or cash flow,
or other varied methods. Here again, the cash flow streams for one's firm have to be
separated from the total project cash flow. The present value at desired discount rates
and/or DCF-ROI can then be calculated. If these are revenue or income dependent, price
sensitivity analysis is highly desirable.