名校 Business Finance 课件2

Investment Appraisal Methods

Business FinanceLecture 2 Investment Appraisal MethodsReadings: McLaney Chpt 4

Investment Appraisal Methods

Outline What is a good decision Time Value of Money Investment Decision Rules Net Present Value (NPV) Internal Rate of Return (IRR) Payback Period (PBP) Average Accounting Return (AAR)2

Investment Appraisal Methods

What is a good decision? What does $240 million buy?

$240 million=1.6% stake + exclusive advertisement

Is this a good deal for Microsoft?3

Investment Appraisal Methods

What is a good decision? Daily life decisions: Choose UNNC? Study abroad? Deciding between jobs?

Financial decision for company: how much to produce? raise prices or increase production? rent or purchase?.....

Balance between benefit and cost !4

Investment Appraisal Methods

What is a good decision? Good decision: Benefit > Cost Any decision in which the value of the benefits exceeds the costs will increase the value of the company. Good decision for company: the one increases the value of the company. Investment Decision is vital since once the decision is made, it cannot be reversed.5

Investment Appraisal Methods

Cost- Benefit Analysis Cash Today: Customer requires: 300 kgs of frozen shrimp today for a total price of $1,500, including delivery. Wholesale market :$3 per kg today, and arrange for delivery at a cost of $100 today. Will taking this opportunity increase the value of the firm? Today's Cost: $3x300+$100=$1000 Today's Benefit: $1500 Today's Gain: $500 Yes! It contributes $500 to the value of the firm! 6

Investment Appraisal Methods

Cost- Benefit Analysis How about the cash flows happen in the future? Investments usually take place over a long period of time The essential feature of investment decision is TIME.7

Investment Appraisal Methods

Time Value of Money For previous example, if the customer will pay 1 year later, what is the gain of the company? Benefit- Cost= $1500-$1000=$500 ???Today Future

Having money now is more valuable than having money in the future

Investment Appraisal Methods

Time Value of Money £1 of present expenditure is not equal in value to £1 receipt in the future, because: Interest forgone –The interest element is an opportunity cost. Inflation – Loss of purchasing power as things will cost more in a year. Risk – The payment today is certain but the anticipated receipt next year is not. We only look at Interest issue today.9

Investment Appraisal Methods

Time Value of Money Shall we invest for £10m now with expectation of £12m return on next year? How do we make comparison between £10m now and £12m in a year’s time? Translate them to the Same Time Point!Today1 year later

Investment Appraisal Methods

Time Value of Money One possible approach: Translate £10m to Future Value and compare it with £12m! Value of £10m after one year with 10% interest: £10m * (1+10%) = £11mWe can now compare the future value of initial investment with the future receipt – They are in the same time point!

£11m < £12m Invest rather than save into the bank!

Investment Appraisal Methods

Time Value of Money Another approa

ch: Translate 1 year later £12m to Present Value and compare it with £10m! To calculate the Present Value (PV) of £12m:£12m = PV + (PV * 10%) £12m = PV * (1 + 0.1) PV = £12m/ (1 + 0.1) PV = £10.9m

Compare with £10m today, £10.9m - £10m >0

So, it is worth to INVEST!

Investment Appraisal Methods

Some Notations Present Value (PV): express the value of money in terms of today's value. Future Value (FV): express the value of money in terms of future's value. Translate from PV to FV-- Compounding Translate from FV to PV-- Discounting The interest rate r convert cash across time.It is referred to discount rate 1/(1+r) is called one year discount factor

Investment Appraisal Methods

Net Present Value (NPV) Net Present Value (NPV): The difference between the Present Value of the investment's benefits and the present value of its cost. NPV = PV (benefits)– Initial investment (cost) The formula of NPV (for 1 year investment): NPV = C0 + C1/1+rThe sign of C0 depends on how you define C0, in any case if it’s investment, it should be a negative number

0 C0

1 year

C1

Investment Appraisal Methods

Net Present Value (NPV) The formula of NPV (for multiple years investment): NPV = C0 + C1/(1+r) + C2/(1+r)2 + C3 /(1+r)3 ..... + Cn /(1+r)n0 1 C1 2 C2 3 C3

The sign of C0 depends on how you define C0, in any case if it’s investment, it should be a negative number

..... .....

n years Cn

C0

where C0 = Investment immediately (time 0) (cash outflow) Cn = Cash flows at each year (cash inflows) r = interest rate

Investment Appraisal Methods

Net Present Value (NPV) NPV = the sum of the discounted values of the cash flow from the investment. Decision Rule: If NPV>0, accept the project: increase the company's value If NPV< 0, reject the project: reduce the company's value More than one projects: choose the one with highest NPV 16 What is the NPV in the example of slide 12?

Investment Appraisal Methods

Example for NPV An IT company has an opportunity to invest in a new high-speed computer that costs £50,000. The computer will generate cash flows (from cost savings) of £25,000 one year from now, £20,000 two years from now, and £15,000 three years from now. The computer will be worthless after three years, and no additional cash flows will occur. This company has determined that the appropriate discount rate is 7 percent for this investment. Should the company make this investment in this new high-speed computer?17

Investment Appraisal Methods

Example for NPV Annual Cash Flows:£ Discount Factor 1/(1+r)n 1=1 1/(1+7%)=0.9346 1/(1+7%)2=0.8734 1/(1+7%)3=0.816318

Year 0 (Cost)Year1 2 3

-50,00025,000 20,000 15,000

Investment Appraisal Methods

Example for NPV Present Values for Annual Cash Flows PV= Cash flows x Discount FactorYear 0 (Cost) Year1 (Cost Savings) 2 3Present Value (£) -50,000x1=-50,000 25,000x0.9346=23,365 20,000x0.8734=17,468 15,000x0.8136=12,244.5 NPV=£3077.519

NPV>0, accept the investment!

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