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# Topic 3_Student - Topic 3 Net Present Value Readings Chap 6...

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Topic 3 Net Present Value Readings: Chap 6 & Chap 4 (4.5)

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Why do we need NPV? How do we know which project to accept and which to reject? What’s the objective of corporate decisions? Maximize shareholders’ wealth Projects that increase shareholders’ wealth should be accepted
NPV How do we know which projects increase shareholders’ value? Need a measure: Net Present Value (NPV) A dollar measure of an investment's effect on the value of a company's assets. For example, if a project has an NPV of \$100,000, doing it would increase the value of the firm by \$100,000 . If a project has an NPV of -\$100,000 , doing it would decrease the value of the firm by \$100,000

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Net Present Value Example You have the opportunity to purchase an office building. The building will generate \$16,000 per year for three years. At the end of three years you anticipate selling the building for \$450,000 after tax. If the building is being offered for sale at a price of \$350,000, would you buy the building? The discount rate of this building is 7%. NPV NPV = - + + + = 350 000 16 000 107 16 000 107 466 000 107 323 1 2 3 , , ( . ) , ( . ) , ( . ) \$59,
Net Present Value You want to decide whether to purchase a new computer system. The initial investment amount required today (CF0) = \$30,000. Without the new computer system, your company’s cash flows are \$30,000 a year forever. If the computer system is purchased, the estimated cash flows will be \$45,000 a year forever. The discount rate of your company is 10%. Should the company buy the new computer system?

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