Lecture03

# Lecture03 - Corporate Finance Theory ECON 360-0-30 Zhiguo...

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1 Corporate Finance Theory ECON 360-0-30 Zhiguo He E-mail: he-zhiguo@kellogg.northwestern.edu Office hours: Thursday 5:00-6:00 pm Room 434, Kellogg Finance Dept 4 th Floor, Andersen Hall Course website: Blackboard http://courses.northwestern.edu/webapps/login

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2 “Just-to-Remind-You” Quiz Last Time: What does time value of money stand for? How is present value linked to future value ? Simple perpetuity , simple annuity, growing annuity and growing perpetuity . Can you work out simple everyday examples?
3 Lecture 3 At a Glance Today: Net Present Value (NPV) Opportunity Cost of Capital Foundations of The NPV Rule

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4 Net Present Value (NPV) Investment Decision Rule : invest if NPV > 0 PV revenue >PV cost do not invest if NPV < 0 PV revenue <PV cost flows] cash future of [PV ] investment [initial - NPV + = = + + = n 1 t t 0 ) 1 ( NPV t r C C NPV = -PV cost + PV revenue Cash flows could be negative!
5 Example: Office Building Construction costs (t=0): \$1,000,000 In one year (t=1) you can sell the building for \$1,210,000 Assume r = 10% PV of future cash flows: Initial investment: \$1,000,000 000 , 100 , 1 \$ 1 . 0 1 000 , 210 , 1 \$ PV = + = Invest 0 NPV \$100,000 \$1,000,000 - \$1,100,000 NPV ] investment [initial - flows] cash future of [PV NPV = = =

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6 Example: Weapons manufacturer Two strategies for developing mine detector device Strategy A : launch the product to market in one year, cost \$1 billion now, earn \$500, \$400 and \$300 million in years 1, 2 and 3, respectively. Strategy B
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Lecture03 - Corporate Finance Theory ECON 360-0-30 Zhiguo...

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