Academic journal article Management Quarterly

Use of Net Present Value Analysis by Electric Cooperatives

Academic journal article Management Quarterly

Use of Net Present Value Analysis by Electric Cooperatives

Article excerpt

The application of sound business principles is critical to the operation of any organization. This is true for profit-oriented companies and not-for-profit associations such as cooperatives. This article focuses on one business practice, Net Present Value analysis (NPV), and its use by electric cooperatives. NPV analysis is widely used by profit-seeking businesses. It should likewise be used by cooperatives as they seek to generate benefits for their members. For NPV analysis to become more widely used by cooperatives, there are two unique problems related to cooperatives that must first be solved.

NPV analysis is a tool that allows managers to determine if a project should be undertaken. It also allows management to determine which is the better project among two or more competing projects. Those managing cooperatives must clearly make such decisions.

An electric cooperative must undertake activities that benefit its members. We first show in this article that a cooperative's "activities that benefit its members" are closely akin to a corporation's efforts to maximize the wealth of its owners. Then, we discuss how NPV analysis is critical to this wealth maximization. The rationale of NPV analysis is then presented, including the two unique problems that relate to its application in the cooperative industry. Finally, an example of NPV analysis by cooperatives is presented.

Wealth Maximization

For a profit-oriented company, it is assumed that management's basic, overriding goal is to create value for stockholders. Most businesses accept the rule that "stock price maximization should be the primary goal of corporate mangers." Some argue that stock price maximization is "bad." They state, for example, that firms should pursue more noble goals, such as the maximization of social well-being. However, most who have studied the principle of shareholder wealth maximization readily admit that all other factors are ultimately embodied within this principle, including social responsibility. Stated differently, all successful businesses seek to do what is best for their owners.

How does this principle apply to electric cooperatives? Some are tempted to state that "we can't do that; we are a co-op." However, are cooperatives really different from their investor-owned counterparts? While the obvious answer to some parts of this question is still "yes," let us look at some very important similarities.

Whether individuals are cooperative members or company stockholders, they are both equity holders in the enterprise. How do they receive a return on their investment? Stockholders expect to receive their return through dividends, capital appreciation, or some combination of these two. For cooperative members, however, the return comes in another form. Traditionally, the cooperative industry has provided this return through cost reduction. By charging prices lower than those charged by investor owned companies, cooperatives have effectively provided a "return" on their members' equity.

This focus on cost is historically engrained. The cooperative movement has, since its beginnings with the Rochdale Pioneers, always focused largely on providing goods or services at or near cost. Most electric cooperatives have, or had at some time, the following as part of their mission statement:

"To provide reliable central electric service at the lowest cost possible consistent with sound financial and business principles."

As the industry and composition of the customer base has changed, modifications of the above statement have become prevalent. Consider, for example, the case of the electric customer who needs not the cheapest power available but rather the most reliable power source. An exclusionary mission focusing on cost alone would not serve this customer. Therefore, while the focus may change, cooperatives still strive to meet the needs of their members.

The members of the cooperative are the equity holders. …

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