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1、,Irwin/McGraw-Hill,Chapter 6,Fundamentals of Corporate Finance Third Edition,Net Present Value and Other Investment Criteria,Brealey Myers Marcus slides by Matthew Will,Irwin/McGraw-Hill,The McGraw-Hill Companies, Inc.,2001,Topics Covered,Net Present Value Other Investment Criteria Project Interacti
2、ons Capital 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,Example Q: Suppose we can invest $50 today & receive $60 later today. What is
3、 our increase in value?,Net Present Value,ExampleSuppose we can invest $50 today and receive $60 in one year. What is our increase in value given a 10% expected return?This is the definition of NPV,Net Present Value,NPV = PV - required investment,Net Present Value,Terminology C = Cash Flow t = time
4、period of the investment r = “opportunity cost of capital”The Cash Flow could be positive or negative at any time period.,Net Present Value,Net Present Value RuleManagers increase shareholders wealth by accepting all projects that are worth more than they cost. Therefore, they should accept all proj
5、ects with a positive net present value.,Net Present Value,ExampleYou have the opportunity to purchase an office building. You have 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
6、 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,Example - continued,Net Present Value,0 1 2 3,$16,000,$16,000,$16,000,$450,000,$466,000,Present Value14,95314,953380,395 $409,323,Example - continued,Net Present Value,Example - continu
7、edIf 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 - continuedIf the building is being offered for sale at a price of $350,000, would you buy t
8、he 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.,Other Investment Criteria,Internal Rate of Return (IRR) - Discount rate at which NPV = 0.Rate of Return Rule -
9、Invest 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 wil
10、l sell the building for $450,000. What is the IRR on this investment?,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 sell the building for $450,00
11、0. What is the IRR on this investment?,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 sell the building for $450,000. What is the IRR on this inve
12、stment?,IRR = 12.96%,Internal Rate of Return,IRR=12.96%,Internal Rate of Return,Calculating the IRR can be a laborious task. Fortunately, financial calculators can perform this function easily. Note the previous example.,Internal Rate of Return,Calculating the IRR can be a laborious task. Fortunatel
13、y, financial calculators can perform this function easily. Note the previous example.,HP-10B EL-733A BAII Plus -350,000 CFj -350,000 CFi CF 16,000 CFj 16,000 CFfi 2nd CLR Work 16,000 CFj 16,000 CFi -350,000 ENTER 466,000 CFj 466,000 CFi 16,000 ENTERIRR/YR IRR 16,000 ENTER466,000 ENTERIRR CPT,All pro
14、duce IRR=12.96,Payback Method,Payback Period - Time until cash flows recover the initial investment of the project.,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
15、than 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.,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 Flows Prj. C0 C1 C2 C3 Payback NPV10% A -2000 +1000 +1000 +10000 B -2000 +1000 +1000 0 C -2000 0 +2000 0,
