BCOR 2200 Chapter 8 w cq

BCOR 2200 Chapter 8 w cq - 1 Chapter 8 Net Present...

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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, short-term money The light bill, salaries, office supplies… • But BIG , long-term 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....
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BCOR 2200 Chapter 8 w cq - 1 Chapter 8 Net Present...

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