This preview shows pages 1–9. Sign up to view the full content.
This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
Unformatted text preview: S I D E R E M E N S E A D E M M U T A T O University of Sydney ECOS2201  Lecture 12 1 Project Selection Which projects should a firm undertake? Calculate Net Present Value of projects revenues and costs and undertake if positive 2 Net Present Value $100 today at annual interest rate of 10% becomes $110 in one year So present value of $110 in one year is NPV = FV 1 + r = 110 1 . 1 = 100 (1) 3 More generally, if get stream of payments in the future, F 1 in one year, F n in n years, then NPV = F 1 1 + r + F 2 (1 + r ) 2 + ... + F n (1 + r ) n (2) Question: Consider a silver mine that requires an investment of 2 mill. immediately and 1 mill. after 1 year, two years, three years, and four years. The mine then starts producing silver and yields net revenue of 750,000 in years 5 to 44 (40 years). Write down formula for NPV? 4 Answer: See board. At r = . 05, NPV=5,042,000 At r = . 1, NPV=160,000 So undertake project if r = . 05 but not if r = . 1 5 Often stream of payments is uncertain price of silver varies as do costs How do we take risk into account when selecting projects? The basic problem  which projects increase a firms value and which projects decrease a firms value? 6 Every project has a cost and produces a random risky stream of net payments Therefore, it is like a share (asset)  it has a cost and a risky stream of payments (dividends) Undertake project (buy a share) if value of risky stream of payments is greater than cost. BUT what interest rate use to discount future values ? How do we do NPV calculation? 7 Expected Return and Variance for a Single Asset Rate of return given by R = p 1 p p , (3) where p 1 is value of asset in period 1 and a random variable and p is value of asset in period 0....
View
Full
Document
 One '09
 NONE

Click to edit the document details