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The Competing Investments Problem. Many companies evaluate more projects than they actually have money for Your boss asks you to do a design for something - you bring it to your boss - he smiles thanks you says it looks good - and then doesn’t put it in the budget

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the competing investments problem
The Competing Investments Problem
  • Many companies evaluate more projects than they actually have money for
    • Your boss asks you to do a design for something - you bring it to your boss - he smiles thanks you says it looks good - and then doesn’t put it in the budget
  • Companies may not consider opportunities that don’t make required return
    • All alternatives that make return are not guaranteed investments
more competing investments
More Competing Investments
  • Some investments are mutually exclusive
    • if you build your new Zebra24 auto plant in DeSoto, you may not be able to build it in Nashville
  • What do you do when you have a bunch of invest and earn problems competing for the same space?
ideas
Ideas
  • Need to recognize that Discounted Cash Flow Analysis may be a requirement to be a competing alternative - it isn’t necessarily the final say
  • Do the subtract one cash flow from another trick and look at the merits of choosing one over the other
the subtract alternative
The Subtract Alternative
  • Investment alternatives may not have the same lives
    • creates potential long negative cash flows at end of comparison
  • All investments may not be of equal size
    • big profitable investments make more money than little ones
    • Is picking the biggest alternative the way to maximize wealth? (Max NPV)
      • Often the fact that alternatives compete means other opportunities are coming
have an irr contest
Have an IRR Contest
  • IRR blows up on “unconventional cash flows”
    • an alternatives list raises the chances that one or more will have blow-ups in them
  • You can tweek a messed up IRR but now you have an investment that is being evaluated on external market conditions against one that is all internal
slide6
PVR
  • PVR was designed for comparing invest and earn cash flows of unequal duration and magnitude
    • It tells you how many dollars of positive NPV you get for every dollar invested
      • This is how it gets around the largest investment wins problem
  • Investments with highest PVR are stronger
have a pvr contest
Have a PVR Contest
  • More alternatives than you know what to do with implies lots of opportunities for your required rate
    • Can have unconventional cash flows without loosing meaning
      • Need to be aware that very large negative flows that will take planning to handle still need external investments
      • Don’t have to go external to get a number like IRR - not getting apples and oranges
pvr is not a surrogate for irr
PVR is not a Surrogate for IRR
  • PVR values cash at your required rate of return
  • Interest rates (especially high ones) shift emphasis to short range returns
    • A highest IRR contest will put emphasis on quick money - not necessarily most
    • PVR values all money at required rate - will maximize the cash you get at your required rate
  • Answers are not equal
even when money rules comparative decisions don t have just one right answer
Even when Money Rules Comparative Decisions Don’t have Just One Right Answer
  • An IRR contest (if you can pull it off - unconventional cash flow problems) tends to give answers that maximize wealth if you can jump in and out of investments
    • Some of the Wall Street raiders of the 80s and 90s
    • Good for Slash and Burn strategy
how do you value money
How Do You Value Money?
  • IRR = Slash and Burn
  • PVR chooses investments that maximize your wealth at your required rate within investments
    • Lets you choose richest portfolio of what is offered now
    • Does tempt people to look in the crystal ball as to what will be offered next (do I hold back part of the money?)
continued
Continued
  • The outside investment world is important
    • an investment that pays out quick will have a good IRR or PVR, but if the present set of opportunities is unusually rich - paying out onto a flat market may not be maximizing future wealth
  • Net Future Value
    • discount money into a future pot at rate of return outside the investment
    • See what makes you richest
nfv or nfw
NFV or NFW
  • Gives you the ability to see impacts in and out of investments
    • now left unequal length and unequal magnitude uncovered
    • May set an arbitrary “get rich date” in the future for unequal length - still may have a pick big tendency.
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