Any project that can earn a business a roi that is greater than the wacc
will help the business be successful.
It is rare that a business will publicly quote its wacc as it is the
determinant of investment selection and therefore valuable competitive
information when bidding against others for opportunities. However, back
in 2002 Coca-Cola, an American drinks company, said in its annual report:
"Our criteria for investment are simple: New investments should directly
enhance our existing operations and generally be expected to provide
cash returns that exceed our long term, after tax, weighted average cost of
capital, currently estimated at between 8% and 10%".
An executive of British Airways, the UK's largest airline, once described
the business as "a group of investment projects fl ying in close formation".
This is an apt description of a business, illustrating that any organisation
is a collection of business decisions, all intended to generate returns that
exceed the cost of funding them.
As anyone who has worked in business will know, the returns anticipated
by business plans are not always achieved and it is the shortfalls
that cause businesses to fail.
The wacc is a fairly constant and predictable
percentage compared with the volatility of a project's performance in
which the investment is placed. For example, an ice cream business excels
in a hot summer, but in a cold and wet summer sales volumes are much
lower. The wacc for both scenarios will be the same.
Once a project has been selected (see Figure 1.2 on the previous page)
the implementation needs to be managed well to achieve the expected
returns. Shareholder value is created by following the cycle in Figure
1.3. Starting at the top, select projects that are rigorously evaluated and
promise high returns.
Manage these projects excellently to fulfi l their
promise. Combining the fi rst two items should enable premium returns
on investment to be achieved. The premium returns should generate
substantial cash fl ow which will provide the resource for future investment
opportunities.
Overall success
Success can therefore be achieved by understanding and satisfying
investors requirements which can be interpreted as "creating a sustainable
superior return on investment". To do this directors need the vision,
business sense and confi dence to invest in ideas and opportunities that
they believe will produce a roi that is greater than the wacc.