The competing investments problem
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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

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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


The competing investments problem

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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