Appendix B - Valuation concepts
Summary
The valuation approaches discussed in Section 1.6 may be broadly applied to any asset class. However, travel industry analysts will also encounter financial notions of internal rates of return (IRR) and economic value added (EVA). The objective here is not to replicate the detail that would be provided in standard texts on financial theory and practice, but to provide a brief introduction to the basic concepts.
Internal rate of return The time value of money is central to all valuation calculations, which must include the number of periods, n, over which cash flows in or out, present value, pv, future value, fv, and an interest rate, r. Using these elements, project investments are decided on the basis of whether the required rate of return – the return in excess of the project's cost of capital – will be earned and whether such a return is by comparison above those that might be earned by other projects also competing for the same capital at the same time. This required rate of return may also be further specified as the required return to debt capital, kd, to equity capital, ke, or to a weighted average of both.
In ranking of alternative investment projects, whether involving a tangible asset such as a new airplane or less tangible assets such as landing rights, an internal rate of return (IRR) analysis is usually helpful, if not always totally decisive. The IRR is defined as the rate of discount, k, that makes the net present value (NPV) equal to zero.
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- Travel Industry EconomicsA Guide for Financial Analysis, pp. 189 - 191Publisher: Cambridge University PressPrint publication year: 2001