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Lecture04_student - Firm and investment valuation How much...

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Unformatted text preview: Firm and investment valuation How much is a firm worth? Calculating net present value Payback period methods Should I invest in green technology? Solar power Wind power Electric vehicles Payback periods Many investments claim something like pays for itself in less than ten years Payment claims are typically undiscounted Sometimes, not discounting can make seemingly good decisions into bad decisions Payback example Another hot summer day You have to water the grass for an hour (again) just to keep it green I wish there was another way There is! Artificial turf Payback example Artificial turf with a 20-year life Initial cost of $5000 to cover a 1000 square foot area Yearly benefits ($650) No mowing $300 No watering $200 Other savings $150 Payback example What the turf company tells you $5000 cost $650 in cost savings per year It pays for itself in less than eight years What does economic analysis tell you? Lets see Payback example Assume we get the benefits at the end of each year If r = 15%, a 20-year annuity, paying $650 per year is worth $4068.57 today Even if we move the first years benefit to be undiscounted, the PV is $4678.85 Payback example Although the payback method tells us when we get our money back, it ignores discounting Proper discounting practices should always be used More on this soon Suppose we use the Payback period method If we navely believe that we invest in anything that gets paid back within a certain number of years, we can make bad investments Lets look at another example Our building-for-sale example Suppose a three-year window (years 0-2) Five offers for a building for sale What if we wanted to get a payback of $110,000 within three years Which offers get us there? $40,000 per year in years 0-2 $21,000 every six months in years 0-2 $15,000 per year in years 0-14 $12,000 per year forever, starting in year 0 $5,900 every six months forever, with the first two payments in year 0 Assume that r = 10% Suppose we only look at a three-year window We look at years 0-2 to determine if we should sell the piece of property Some offers look good (> $110,000) $40,000 per year in years 0-2 $21,000 every six months in years 0-2 Some do not All other offers pay $45,000 or less in the first three years What was really the best offer?...
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This note was uploaded on 12/05/2011 for the course ECON 134a taught by Professor Lim during the Fall '08 term at UCSB.

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Lecture04_student - Firm and investment valuation How much...

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