(L07)Applied_ns

(L07)Applied_ns - Primbs/Investment Science 1 Topic 7:...

Info iconThis preview shows pages 1–12. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Primbs/Investment Science 1 Topic 7: Applied Interest Rate Analysis Reading: Luenberger Chapter 5, Sections 1, 6 Primbs/Investment Science 2 Applied Interest Rate Analysis Capital Budgeting Valuation of a firm Primbs/Investment Science 3 Capital Budgeting Deciding on which projects to invest in. C 1 C 2 C m Primbs/Investment Science 4 Capital Budgeting We need to choose a portfolio of these projects which maximizes our net present value. In this portfolio, we either select the entire project or we dont do it at all. We cannot do a half of a project. Primbs/Investment Science 5 A simple heuristic: Benefit-Cost ratio Rank projects according to their benefit-cost ratio where here benefit refers to the present value of the cash flows received after the initial cost. C 1 PV=B 1 Select the projects with the maximum benefit-cost ratio until the budget constraint is reached. (This procedure is not optimal) Primbs/Investment Science 6 Example Project Cost Benefit Benefit/Cost 1 100 300 3 2 20 50 2.50 3 150 350 2.33 4 50 110 2.20 Budget: $150 Select Projects 1 and 2. Primbs/Investment Science 7 Optimal Capital Budgeting Select a portfolio of these projects. c 1 b 1 =PV (of entire cash flow stream) x 1 Project 1: c 2 b 2 =PV x 2 Project 2: c m b m =PV x m Project m: Primbs/Investment Science 8 Optimal Capital Budgeting Let x i represent the amount of project i. x i =0 or 1 . The present value of our portfolio of chosen projects is: = = + + + m i i i m m b x b x b x b x 1 2 2 1 1 ... The cost of this portfolio is: = = + + + m i i i m m c x c x c x c x 2 2 1 1 ... Primbs/Investment Science 9 Optimal Capital Budgeting (Can be solved in Excel) = m i i i x x b 1 max (Present Value) C x c m i i i = 1 s.t. (Budget Constraint) 1 or = i x for i=1,...,m (All or nothing) Primbs/Investment Science 10 Interdependent Projects Different projects may represent different implementations of the same thing. Hence, we can choose one at most. c 1 b 1 =PV Project 1: c 2 b 2 =PV Project 2: Underpass Traffic Light c m b 4 =PV Project 4: c 1 b 3 =PV Project 3: One Lane Two Lane Primbs/Investment Science 11 Optimization (More complicated dependencies can be handled likewise) (See Spreadsheet Example) = m i i i x x b 1 max (Present Value) C x c m i i i = 1 s.t....
View Full Document

This note was uploaded on 01/24/2009 for the course MS&E 242 taught by Professor Primbs during the Fall '06 term at Stanford.

Page1 / 38

(L07)Applied_ns - Primbs/Investment Science 1 Topic 7:...

This preview shows document pages 1 - 12. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online