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Alfred Rappaport's definition of shareholder wealth (value)
Shareholder value = corporate (business) value - Debt
The corporate value represents the perpetuity of cash flows forecast to be generated by the organisation from all of its projects, discounted to present value; this would include the residual value of any assets at the end of the forecast period, also the value of any marketable securities (investments) the company owns. In effect the value of a company and therefore shareholder wealth would be the net present value (NPV) of all of the companies projects considered over a period of time, less the payment of any obligations e.g. debt. NPV indicates that the present value of cash-flows from a project should exceed the opportunity cost of investment e.g. the cost of capital. The main problems of this approach is deciding what discount rate to use, over what period of time to discount and forecasting cash-flows can be very uncertain.
One way to ensure greater control over investment decisions is to use economic measures such as residual income (RI) and economic value added (EVA). Both of these measures include a finance charge deducted to represent the opportunity cost of 'tying money up' within a division. When considering RI or EVA as a measure for investment appraisal, the operating cash-flow generated when considering new investment, must exceed the hurdle cost of capital applied to the investment outlay.
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