bma 5- net present value
TRANSCRIPT
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ol these
rate uf retum
cal
culata and
rules
resent e
t
er
Invest
to be rleh rather lhan
in eveht
The difteranee
shareholders
pesitive
NPV
end
thrr net prrrsrrnt value
somrr other measures that
0 r '0n:, , , , , , , ;;
investment deoisiuns The flrst Tho
Its dook
more aecurate when r l , inninn
financial manager
suhstantial
mere han a rule l thumh when
investment deelslen
NPV
e
Instecd
eompnre the exeretod
wilh me retum thel shareholdrrrs rrould
rram
on
invectmrrnts in tha madrrrt Phe ecmpany aoerrpts thosrr
prcjects hal previdrr rrrtum thec sharaholdrrrs erruld
thrrmsatrec If usod this rale 1 ratum rula
shrruld
situatinns whrrn thrr
frm
has
odo
ehonsa thnsrr
thal Inerrursa jjrm vrtua n w ~
savrrrrt traps fnr me unwruy
enprr with
n l ~
Invrrstrrd bUI mnre rrlabnratrr
nrrrrdrrd
what? NPV
1 5
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ne Value
flews
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Net Present Vrr ue rrnd
mlrrstmrrnt
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Valua
Proltablity miau:
Payl:ck:
o
t FIGURE Suuxeyevltlent:e
hwestment projec s.
60
%
wh
I
80
particular technique
al Finance: Evidenee lrom the Fel, Jaumal
ar Financlal
cormmies 5 ZIJOll,
measures do nnl have this
and
Book
slmph:
h . ; : ; ~ r J . n m 5
uf no v onk
rtturn
cakulkJ anu
of
the differtnce
f 1 o \ l , - ~ Rt:?o th,;; if
yOS)
tu refrtdl. yuur uncln-smlng nf
thl
5tH], do lhr
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Net Present Value
500
1
+ 2,624
shouk1 i:. ktn J cunt
n
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ne Value
also an inital
of 52,000
1 and 81,800 yca: 2,
At 10
500
1,800
~ 2 0 0 0
~ 5 8
10
as thc two
first
1,800
500
~ 2 0 0 0
+ 50
.10
Yoo
as illustrated
discuunted cash flows fcu our
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w
makes PV O
In ,,,, 'I,,, 'ot
ritera
the dscount
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Valu6
rate
PV
Actual calcularan of
IRR
of
the
PV
=
~ 4 0 0 0
~
zero discmmt rote
lJlOO
~ 4 O O O
~ l
4 000
o
Dol zero but
~ 8 8 9
O
the
be
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Present Value and
Other Investment
~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~
SCOllrlt
rata
%
the discmmt rate
FIGURE 5.3
duccs
2,000
4,000
intcma 01
(IRR) is 213 , thc mtc
01 whlch
NPV
o
+
,000
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1
One
The mine
mR
and its follows:
Note rhat [here are tw rates that NPV
o.
3,
o
ments
m
o
m
NPV
~ 3 0
..
o
.035
BEYOND
m
10 10
rrrrrrrrrr
N
~ 3 0
o
1.1954
L
In
otOer
internal
1111 \1,
A billons
iRriR iR - t w O m - t ~ 1
+1
R iR 1
+1
11
lO 15
30
35
[)iSGount (ate,
t FIGURE 5iR
[W
'
O whon
rato
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5
Net Present Value and Other m U D , , , r r , , ~ n r
company
of rcturo
lCompanks urouad the pmbk-m of muhiplt rates of return
unUl femulns 00.1) one changt ;n the sign nf1he c.J.sn
flh'S,
tnen
be
cakuh.ted
nn
hi, llw
i\HRR
calculated follow",
L
nO
ull he subseqcenl uow:
PV lu \GiU lO/U' IOiU' y OIU'
AJd
o Ihe
now he presenl value al' subStquenl r
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1
Value
foHows:
FIGURE
Projec
G
Jiscount rata, %
o YDU mar, DO\1cver,
tba1 ynu
jumpeJ uf tnt' frying Km the f n ~ The
lnvoh'f
in sign, in his Ihtf ft likdy bn ffiullip0 mR, nn w l be
l
Ihe
h often
suggfst2-d
1hu tht ChOlc(, bebt>fen lhe
Dei
presen
v:due
ruk and
intnnal
rale of ftturn ruie
snu1d
De:pend On
J.bk
Ths v w n g ~ The prospective on anthe(
indeprnd nt
lnvcs nwnl should
m'h'Tbe
alkHvtQ to
Ihe
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Net Present Value Investment riteria
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8
alue
on
4ln 9
nther for
L.n:g+:rm c;}sh
Hm< .
COmpilOj t day n d ~ r t ; l . k m g J
d ,'D, _''W_ITHnn'V (pruject generJJly
pa}';;
to
' < d ~ ~ n ~ t h > m o n e (
{ p r n j ~ c t
n II mJ.kes
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Net
Other nvestment
he
Jtnomim or
"hould be lhe rrosen
value
of hu
nUllayu.
comptmt
Jo
nnt Tbe 58iJ Jonu he buBer
value u inHLd ouday, that b,
si m,, }'
ucid
LO lO
ueh prn[;hilty inciex,
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12 ODa
H H I H I I r ~
apital ratoning mojels
5
O
j 5
mnner
lm ,, er prnt1tablBty
h ~ t in he
Aprend
lo Chrrptff
Dad
12
the
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I IRR Internal
XIRR The
But that h too a
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Pan
One
SUMMARY
Value
1s not rationed, other resources may be.
The
availabilit}'
of
management
or even other capital equipment often constitutes an important cOl1straint
011
a
Hard should never cost the
fi1 m
constraints
become tight
to hurt- in
the sense that with NPVs are
passed
up-then
the firm raises more money and ooseos the constraint. But what if
ir
alll t
mise more
money-what
if it faces
Ulrd
Hard rationing implies market
to
thmw
away net present value
as
a crHerion fm
of the imperfection.
mean
we
have
on the nature
Arizona Aquaculture, ne. (AA ), bormws as much
as
the banks
willlend it t
still has
good investment opportunities. This is not hard so as AAI can issue stock But
perhaps it can't. Perhaps the fouoder and majority shareholder vetoes the idea from fear
control of the frm. Perhaps a stock ssue would bring red or
This doe:; flot invalidate the NPV rule. AA 's s wrellOlders can borrow or
shares,
or
buy more. The}' have free access to security markets.
The
type
is independent
of
AA 's
finandng Ol"
investment decisions. The way AAI can
shareholders s
to rpak,e
them richer
.Thus
AAI should invest its available casI in the
pac:Kaj;;e
of
projects having the largest aggregate net present valuc.
A barrier between the firm and capital markets does
BOt
ul1dermine net value so
long
as
the barder is the
oll y
market imperfection.
The
important
i5
that the firn
slwrellOlders
have free acces:; to well-functioning capital markets.
The net present value rule is undermined when imperfections restrict shareholders'
folio choice. Suppose that Nevada Aquaculture, ne. (NA ), Is solely owned by its
Alexander
Turhot
Mr. Turbot
ha5110
cash or credit remaining, but he is convinced that expan
sion
of
his operation is a high-NPV investment. He has tried to seH stock but has found that
investors, skeptical
of
prospects for [sh farming in the desert, offer him much less
than he thinks his [rm s worth. For Mr. Turbot capital markets hardly
exist It
makes Hule
seme
fm him to discount prospective cash
tlOW5
at a market opportunity cost
of
capital.
A
nllljorly ",,"oer
"1,,,
is Iockd
-
""d
11 ,
nlllcJ
pcrsmml wcal h le. up in
AA
mal' be
efic,tivc r
cut off
[mm
capital market5.
The NI'V ruk mol' nol
mOKC
sen" lo ,d, on
OIVlle,.
""gil il \VII
n
lile Ihcr 'MrdwIJers.
IfyOl are gaing to persuade yuur campany to use the net value yau must be
to explain
why
other rules may
lIal
ead
to
correct decisions. That
is we
have examined three
alternatve investment crteria in this chapter.
Some firms look at the book rate of return on the project In this case the company decides
whieh cash payments are capital expenditures and picks the appropriate
cate
to depreciate these
lt
then calculates the ratio of book income to the book value
of
the investmcnt
Few
w ~ ' ' ' ' v < base their investment dedsion simply on the book rate of retum, but share
holders
pay
attention
lO
book measures of frm prontability and sorne managers therefore look with
a that would the company's book rate of return.
So me
method to make lnvestment decisions. In other words,
accept that recover
thei.
initiai nvestment within sorne specified
Payback
i5
ao ad hoc rule.
It
of cash flows within the payback period,
and it ignores cash flows It therefore takes no account
of
the opportunity
cest of capital.
The internal rate of rcturn (IRR)
i5
defined
as
the rate of discount at whieh a would
have zera NPV.
It
is a handy measure and widely used in finan
ce; you
should therefore know how
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Net Present
Other
nVAnt
riteria
:mil
DecisioflS,