Fundamentals of Corporate Finance Third edition Chapter 6 Net present Brealey Myers Marcus Value and Other ndamentals of Corporate Finan Investment Criteria Brealey Myers Marcus slides by Matthew will IrwinMcGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 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
6-2 Topics Covered SNet Present Value SOther Investment criteria pRoject Interactions Capital rationing Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 2 Irwin/McGraw-Hill Topics Covered Net Present Value Other Investment Criteria Project Interactions Capital Rationing
6-3 Net present Value Net Present value- Present value of cash flows minus initial investments Opportunity Cost of Capital -Expected rate of return given up by investing in a project Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 3 Irwin/McGraw-Hill 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
6-4 Net present Value Example Suppose we can invest $50 today and receive $60 in one year. What is our increase in value given a 10% expected return? 60 Profit=-50+ =$4.55 1.10 $4.55 Added value $50 Initial Investment This is the definition of npv Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 4 Irwin/McGraw-Hill Net Present Value Example Suppose 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 Profit = -50 + 60 1.10 = $4.55 Initial Investment Added Value $50 $4.55
6-5 Net present Value NPV=PV- required investment NPV=C+ (1+r) C NPV=co+ 2+ (1+r)(1+r) 2 (1+r Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 5 Irwin/McGraw-Hill Net Present Value NPV = PV - required investment NPV C C r t t = + + 0 (1 ) NPV C C r C r C r t t = + + + + + + + 0 1 1 2 2 (1 ) (1 ) 1 ... ( )
6-6 Net present Value Terminology C=Cash flow t= time period of the investment r=opportunity cost of capital o The Cash Flow could be positive or negative at any time period Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 6 Irwin/McGraw-Hill Net Present Value Terminology C = Cash Flow t = time period of the investment r = “opportunity cost of capital” The Cash Flow could be positive or negative at any time period
6-7 Net present Value Net Present Value rule Managers 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 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 7 Irwin/McGraw-Hill Net Present Value Net Present Value Rule Managers 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
6-8 Net present Value Example ou 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 would you be willing to pay for the building? Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 8 Irwin/McGraw-Hill Net Present Value Example You 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 would you be willing to pay for the building?
6-9 Net present Value $466,000 Example- continued $450.000 $16,000 $16,000 $16,000 Present value 0 14. 953 14953 380.395 S409,323 Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 9 Irwin/McGraw-Hill Net Present Value 0 1 2 3 $16,000 $16,000 $16,000 $450,000 $466,000 Present Value 14,953 14,953 380,395 $409,323 Example - continued
6-10 Net present Value Example - continued If the building is being 〓〓 offered for sale at a price of$350,000, would you buy the building and what is the added value generatea by your purchase and management of the building? Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 10 Irwin/McGraw-Hill Net Present Value Example - continued If 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?
