Net Present Value and Other Investment Criteria.ppt
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1、,Irwin/McGraw-Hill,Chapter 6,Fundamentals of Corporate FinanceThird Edition,Net Present Value and Other Investment Criteria,Brealey Myers Marcusslides by Matthew Will,Irwin/McGraw-Hill,The McGraw-Hill Companies, Inc.,2001,Topics Covered,Net Present ValueOther Investment CriteriaProject InteractionsC
2、apital Rationing,Net Present Value,Opportunity Cost of Capital - Expected rate of return given up by investing in a project.,Net Present Value - Present value of cash flows minus initial investments.,Net Present Value,ExampleSuppose we can invest $50 today and receive $60 in one year. What is our in
3、crease in value given a 10% expected return?This is the definition of NPV,Net Present Value,NPV = PV - required investment,Net Present Value,TerminologyC = Cash Flowt = time period of the investmentr = “opportunity cost of capital”The Cash Flow could be positive or negative at any time period.,Net P
4、resent Value,Net Present Value RuleManagers increase shareholders wealth by accepting all projects that are worth more than they cost. Therefore, they should accept all projects with a positive net present value.,Net Present Value,ExampleYou have the opportunity to purchase an office building. You h
5、ave a tenant lined up that will generate $16,000 per year in cash flows for three years. At the end of three years you anticipate selling the building for $450,000. How much would you be willing to pay for the building?,Net Present Value,0 1 2 3,$16,000,$16,000,$16,000,$450,000,$466,000,Present Valu
6、e 14,953 14,953 380,395$409,323,Example - continued,Net Present Value,Example - continuedIf the building is being offered for sale at a price of $350,000, would you buy the building and what is the added value generated by your purchase and management of the building?,Net Present Value,Example - con
7、tinuedIf the building is being offered for sale at a price of $350,000, would you buy the building and what is the added value generated by your purchase and management of the building?,Other Investment Criteria,Internal Rate of Return (IRR) - Discount rate at which NPV = 0.Rate of Return Rule - Inv
8、est in any project offering a rate of return that is higher than the opportunity cost of capital.,Internal Rate of Return,ExampleYou can purchase a building for $350,000. The investment will generate $16,000 in cash flows (i.e. rent) during the first three years. At the end of three years you will s
9、ell the building for $450,000. What is the IRR on this investment?,IRR = 12.96%,Internal Rate of Return,IRR=12.96%,Payback Method,Payback Period - Time until cash flows recover the initial investment of the project.The payback rule specifies that a project be accepted if its payback period is less t
10、han the specified cutoff period. The following example will demonstrate the absurdity of this statement.,Payback Method,ExampleThe three project below are available. The company accepts all projects with a 2 year or less payback period. Show how this decision will impact our decision.Cash FlowsPrj.
11、C0 C1 C2 C3 PaybackNPV10%A-2000+1000+1000+100002+7,249B-2000+1000+1000 02- 264C-2000 0+2000 02- 347,Book Rate of Return,Book Rate of Return - Average income divided by average book value over project life. Also called accounting rate of return.Managers rarely use this measurement to make decisions.
12、The components reflect tax and accounting figures, not market values or cash flows.,Project Interactions,When you need to choose between mutually exclusive projects, the decision rule is simple. Calculate the NPV of each project, and, from those options that have a positive NPV, choose the one whose
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