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Unformatted text preview: The Investment Decision Producing the movie Cost =>$200 million Revenue => 1,835 million Channel Tunnel => $18 billion Net Present Value Net Present Value Present value of cash flows minus initial investments. Net Present Value Example Q: Suppose we can invest $50 today & receive $60 later today. What is our increase in value? Initial Investment Added Value $50 $10 A: Profit =  $50 + $60 = $10 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 Net Present Value Opportunity Cost of Capital Expected rate of return given up by investing in a project. Net Present Value NPV = PV  required investment NPV C C r t t = + + 1 ( ) NPV C C r C r C r t t = + + + + + + + 1 1 2 2 1 1 1 ( ) ( ) ... ( ) Net Present Value Terminology C = Cash Flow t = time period of the investment r = “opportunity cost of capital” c The Cash Flow could be positive or negative at any time period. 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? Net Present Value $16,000 $16,000 $16,000 $450,000 $466,000 0 1 2 3 Present Value 14,953 14,953 380,395 $409,323 Example continued 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? 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? NPV NPV =  + + + = 350 000 16 000 107 16 000 1 07 466 000 107 323 1 2 3 , , ( . ) , ( . ) , ( . ) $59, Net Present Value Net Present Value Rule 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. Pros and Cons to the NPV rule Pro c Includes Time Value of Money (TVM) c Measures increase in value Con c Confusing to some people c Problems if firm is capital constrained Excel Help Excel has the following function NPV ( rate , value1 ,value2, ...) It calculates the net present value of an investment by using a discount rate and a series of future payments (negative values) and income (positive values).values) and income (positive values)....
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This note was uploaded on 10/27/2010 for the course FIN 3300 taught by Professor Jerry during the Winter '10 term at CSU East Bay.
 Winter '10
 jerry
 Net Present Value

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