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: 1 Chapter 8 Net Present Value & Other Investment Criteria 2 We’re starting a new section of the Course: Section 1 – Overview – Ch 1: Intro Section 2 – Financial Statements and CFs – Ch 2: Financial Statements and CF definitions – Ch 3: Ratios Section 3 – Valuation of future CFs – Ch 4: Intro to TVM (Single CFs) – Ch 5: More TVM (Multiple CFs) Section 4 – Stocks and Bonds – Ch 6: Bonds – Ch 7: Stocks Section 5 – Capital Budgeting – Ch 8: NPV and other Decision Criteria – Ch 9: Making Cap Budgeting Decisions – Calc CFs 3 Capital Budgeting is… • Budgeting the firm’s capital • Spending the big money – Not small, shortterm money The light bill, salaries, office supplies… • But BIG , longterm money – These are called Capital Expenditures • So if a firms sells stocks, sells bonds, retains earnings… • What does it do with the money? 4 Here’s the idea: • The CAPITAL BUDGETING DECISION is about ADDING VALUE to the firm • To pay for capital investments, a firm can sell stocks, sell bonds or retain earnings… • But SHOULD a firm sell stocks, sell bonds or retain earnings? – Does it have something WORTHWILE to do with the money? – Does it have GOOD CAPITAL PROJECTS ? – Does the proposed project ADD VALUE ? • If the proposed project does not add value… – Then DON’T sell stocks, DON’T sell bonds, DON’T retain earnings – Instead the firm should PAY DIVIDENS 5 Net Present Value • So how do we know if a proposed project Adds Value ? • We calculate the proposed project’s Net Present Value • Called NPV Here’s how NPV analysis works: • The decision rule: – If the Net Present Value is POSITIVE – Then the project Adds Value – So the company should Invest the Capital ( or Budget the Capital) 6 Net Present Value is 1. The PV of all the project’s future cash flows… – CF 1 , CF 2 , CF 3 ,… 2. Discounted at the Proper discount rate (R)… – A higher discount rate for riskier projects – A lower discount rate for less risky projects 3. Plus the initial (time 0) cash flow... – CF 0 is the Initial Cost of the project – CF is usually an outflow, so it is usually negative • If the PV of the future CFs is greater than the cost: • Then the NPV > 0 and the project Adds Value! 1. If the company can Spend $100 today 2. For something Worth $110 (in PV terms – so also “today”) 3. The do the project! 7 How to think about NPV • Think about paying $1,000 today for “something” – A bond, an annuity, a truck, a machine… • Assume that “something” will pay a net of $400 per year for the next 3 years • Also assume the proper discount rate is 10% • So pay $1,000 now for $400 at time 1, 2 and 3....
View
Full Document
 '08
 TOMNELSON
 Net Present Value, CF

Click to edit the document details