Opportunity Cost Could have invested in alternative projects DCF Concept and

Opportunity cost could have invested in alternative

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Opportunity Cost: Could have invested in alternative projects
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DCF Concept and Steps Concept : A valuation method used to estimate the attractiveness of an investment opportunity. DCF analysis uses future cash flow projections and discounts them to arrive at a present value estimate which is used to evaluate the potential for investment. Steps : 1. Estimate the relevant cash flows. 2. Calculate the rate of return for the investment. 3. Compare the returns to your acceptance criterion.
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Key Informational Needs Information you need: n = number of periods (time ) i = interest rate PV = present cash flows PMT = annuity stream of cash flows FV = future cash flow ****For ease, use a financial calculator phone app (e.g. Ez Calculators)!
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DCF Concept: Present Value Present Value : The current worth of a future sum of money or stream of cash flows given a specified rate of return. To compute the PV of money you ll receive some years from now, a discount rate is applied PV = FV/(1+i) n If someone offered you $500 today or $1000 in ten years, and inflation is 3%, which would you take? What if inflation rate is 1%? Or 8%? Future cash flows are discounted at the discount rate : - Reflects time value of money, risk or uncertainty of future cash flows - More uncertainty of cash flows: the higher the discount rate and lower the PV of future cash flows
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DCF Concept: Future Value Future Value : The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today. Most common application is compounding: The Future Value of money you have today at an interest rate FV = PV x (1+i) n (i = interest rate, n = # periods) Exampl e: $1000 invested today, Interest rate = 10%, Time = 5 years would have a Future Value of $1,611.00.
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Net Present Value (NPV) Investing money now for a future payback involves risk Alternative projects might provide a better return NPV is the gold standard for getting the answers; it measures value creation NPV is the PV of the expected cash flows minus the initial investment Positive NPV= Expected payback is greater than the cost of doing it, accounting for time and risk
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Formulas
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DCF Steps: Steps: 1. Estimate the relevant cash flows. 2. Calculate the rate of return for the investment. 3. Compare the returns to your acceptance criterion. But: 1. Step #1 is challenging. 2. Doing it well requires a thorough understanding of the company s markets, competitive position, and long-run intentions. 3. Potential estimation difficulties arise with financing costs, working capital investments, shared resources, excess capacity, contingent opportunities, etc….
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Next Class: January 30, 2019 Readings for this Class : Higgins, R. (2007). Analysis for Financial Management. Chapter 7 Homework Due: 1/30: Blood Analyzer: On Gauchospace Course Website Reminder: Practice Round Deadlines : Monday, 2/4 CAPSIM Introduction: Read CAPSIM Manual & do Tutorial before class! Tuesday, 2/5 by 11PM PT: Practice Round 1 Thursday, 2/7 by 11PM PT: Practice Round 2 Sunday, 2/10 by 11PM PT: Practice Round 3
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