New World Development Company Limited Diversify or Focus Case Solution

1. Do the divisions add economic value?

Some of the company’s divisions create economic value while others are adding to the debt burden of the company. While it has to be understood that newer capital investments into the company’s divisions will add to the debt burden in several cases, the divisions have to provide the cash flows to be of economic value. Currently, the company’s core business of investments into property is bearing fruit for the company. Future investment plans in line are also likely to bring cash flows for the company. This is because the company’s management is quite dexterous in property investment and has been the pioneer in the field.

However, the telecom division has led to a large number of losses for the company. Most of the divisions which are not adding economic value to the company are due to the prevailing uncertainty in the company’s operations. Future investors are doubtful about the company’s ventures; hence, not willing to invest in the long run. Although the company signed lucrative deals in the telecom business, the costs of operation and expenditures went well beyond the company’s reach; thus, causing a worsening debt balance. On the other hand, a construction business, in the long run, seems to hold a great potential for the company with new projects coming in.

Moreover, if the performance of infrastructure and hotel division is compared, the hotel division appears to have performed better. Hence, the hotel division apparently adds economic value to the company. On the other hand, while some infrastructure projects have provided good revenues to the company, the heavy investment required in infrastructure projects such as roads and bridges has led to high expenditures in this division. Therefore, profitability has been lower in this division. Due to comparatively lower initial investments required in the hotel division, improved returns have been experienced. To summarize, the construction, hotel, and property divisions have added useful economic value to the company while other divisions have failed to add such value.

2. Does the company as a whole create value?

As per the financial results presented in case exhibits, the company as a whole is not creating value. Rather, the company is running into cash flow problems. The whole company’s performance and value creation are dependent on its current divisions and its divestment into newer ventures. The divisions and investments other than the company’s existing ones are also linked to the company’s current line of businesses. Hence, the company is divesting into businesses that are somewhat connected to its current line of business. Although such businesses are not adding to the overall value of the company currently, it is likely that some of these businesses would be profitable in the long run.

In the given scenario, while some divisions of the company are creating value individually for the company, various other divisions are causing further financial burdens. Therefore, the company as a whole will not create value until its profitable divisions depict a net present value higher than the losses incurred by underperforming divisions. Moreover, since the hurdle rate is an important determinant of the performance of various divisions and for the company as a whole, its calculation and judgment need to be more accurate to identify the real value creation of the company. The significance of the hurdle rate can be judged by the fact that investors base many of their decisions on this factor.

Moreover, it is expected that the company’s investments into non-conventional divisions and moving away from its given portfolio will create value for the company. For example, with increased resource investment and extension into department stores, more economic value is expected as more people start to shop in department stores.