NPV - NPV and Project Valuation 1 The Financial Manager 2...

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1 NPV and Project Valuation 2 2 The Financial Manager ± Who is the financial manager? ± Anyone responsible for significant financial decisions for a company. ± The key financial managers are usually the CFO, the treasurer and, for larger companies, the controller. ± In the largest companies, they may report to the chief financial officer (CFO). ± Several different aspects to the financial manager’s job: ± Understanding capital markets. ± Understanding valuation and investment decisions. ± Understanding the effects of time and uncertainty (risk).
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3 The Financial Manager’s Objectives ± Although many claim-holders have a stake in the firm’s income, the shareholders are the firm’s owners , and managers should act in shareholders’ best interest. ² There are potential conflicts of interest between management and shareholders, and among the various claim-holder groups. ± Shareholders are made better off by any decision that increases the value of their stake in the firm. Therefore, managers should act so as to maximize the value of the shares of the firm . ² Stockholders are the residual claimants (they only get a piece of the pie after the other claimants are paid what they are owed). ² Maximizing their stake will generally be consistent with maximizing everyone’s stake (i.e., the whole pie). ² This is a more complex objective than maximization of profits and requires an understanding of how financial assets are valued. 4 Net Present Value: A tool for evaluating projects Suppose you have $350,000, and you are considering whether to invest in a project that is expected to return $400,000 in one year’s time. Alternatively, you could leave your money in the bank at 3%. Should you invest in the project? If you leave your money in the bank, you will have 350,000(1.03) = $360,500 in one year’s time. On this basis, the project that returns $400,000 looks like a good bet. What is the discount rate generated by the project? 350,000(1+r) = 400,000 r = 14.3% • Which project do you prefer? • What other key factor should we consider before deciding whether to invest?
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5 Net Present Value: A tool for evaluating projects cont’d The Net Present Value of the project is: NPV = - 350,000 + 400,000 / (1 + r) If r = 14.3%, what is the NPV? • If an investor demanded a higher rate of return on this project, based on her perception of the project’s risk, would she invest in this project? • What about if she would be willing to accept a lower rate of return on this project? • What is the relationship between “risk” and “r”? 6 Net Present Value: Scenario Analysis Suppose that there are three equally probable scenarios for the project’s outcome one year from now: Bad OK Good $200,000 $400,000 $600,000 What is the expected payoff from the project? 0.33 (200,000) + 0.33 (400,000) + 0.33(600,000) = $400,000 …but this payoff is risky. If we end up in the “bad” state, we will lose $150,000 on the project.
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NPV - NPV and Project Valuation 1 The Financial Manager 2...

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