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1、,Where Positive Net Present Values Come From,Principles of Corporate FinanceSeventh Edition Richard A. Brealey Stewart C. Myers,Slides by Matthew Will,Chapter 11,McGraw Hill/Irwin,Copyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved,Topics Covered,Look First To Market Values Forecas
2、ting Economic Rents Marvin Enterprises,Market Values,Smart investment decisions make MORE money than smart financing decisions,Market Values,Smart investments are worth more than they cost: they have positive NPVs Firms calculate project NPVs by discounting forecast cash flows, but . . .,Market Valu
3、es,Projects may appear to have positive NPVs because of forecasting errors e.g. some acquisitions result from errors in a DCF analysis,Market Values,Positive NPVs stem from a comparative advantage Strategic decision-making identifies this comparative advantage; it does not identify growth areas,Mark
4、et Values,Dont make investment decisions on the basis of errors in your DCF analysis.Start with the market price of the asset and ask whether it is worth more to you than to others.,Market Values,Dont assume that other firms will watch passively. Ask - How long a lead do I have over my rivals? What
5、will happen to prices when that lead disappears In the meantime how will rivals react to my move? Will they cut prices or imitate my product?,Department Store Rents,EXAMPLE: KING SOLOMONS MINEInvestment = $200 millionLife = 10 yearsProduction = .1 million oz. a year Production cost = $200 per oz.Cur
6、rent gold price = $400 per oz.Discount rate = 10%,Using Market Values,EXAMPLE: KING SOLOMONS MINE - continuedIf the gold price is forecasted to rise by 5% p.a.: NPV = -200 + (.1(420 - 200)/1.10 + (.1(441 - 200)/1.102 +. = - $10 m. But if gold is fairly priced, you do not need to forecast future gold
7、 prices: NPV = -investment + PV revenues - PV costs= 200 + 400 - S (.1 x 200)/1.10t) = $77 million,Using Market Values,Do Projects Have Positive NPVs?,Rents = profits that more than cover the cost of capital NPV = PV (rents) Rents come only when you have a better product, lower costs or some other c
8、ompetitive edge Sooner or later competition is likely to eliminate rents,Competitive Advantage,Proposal to manufacture specialty chemicals Raw materials were commodity chemicals imported from Europe Finished product was exported to Europe High early profits, but . . . . . . what happens when competi
9、tors enter?,Marvin Enterprises,Marvin Enterprises,Marvin Enterprises,Demand = 80 (10 - Price) Price = 10 x quantity/80,Demand for Garbage Blasters,Marvin Enterprises,NPV new plant = 100 x -10 + S (6 - 3)/1.2t ) + 10/1.25= $299 millionChange PV existing plant = 24 x S (1/1.2t ) = $72 millionNet benef
10、it = 299 - 72 = $227 million,Value of Garbage Blaster Investment,Marvin Enterprises,VALUE OF CURRENT BUSINESS: VALUE At price of $7 PV = 24 x 3.5/.20 420 WINDFALL LOSS: Since price falls to $5 after 5 years, Loss = - 24 x (2 / .20) x (1 / 1.20)5 - 96 VALUE OF NEW INVESTMENT: Rent gained on new inves
11、tment = 100 x 1 for 5 years = 299 Rent lost on old investment = - 24 x 1 for 5 years = - 72227 227 TOTAL VALUE: 551 CURRENT MARKET PRICE: 460,Marvin Enterprises,100 200 280,NPV new plant,Change in PV existing plant,Total NPV of investment,400,600,200,-200,NPV $m.,Addition to capacity millions,Alternative Expansion Plans,
