chapter  7
16 Pages

Transnational Energy Companies’ Investment Allocation Decisions

ByPetter Osmundsen, Magne Emhjellen and Morten Halleraker 105

Since materiality is the size of the net present value of the project after tax, and traditional valuation by companies is defined as the discounted cash flow method, materiality becomes a function of expected after tax cash flow and the discount rate. The expected after tax cash flow is related to the size of the project itself, the company’s equity share in the project and the tax level. The discount rate is the appropriate required rate of return dependent on the systematic risk (non diversifiable risk) of the project. Consequently, company approval of an investment will depend on the perceived risk of the project (the non diversifiable portion), the project size, the company’s equity share and the tax level. In addition to these materiality variables companies are aware that there might be option values related to projects. Option value(s) are therefore an additional materiality variable that might affect companies’ investment incentives.