1 / 21

Finance I

Finance I. October 10. Topics covered. Capital budgeting: decision-making process for accepting or rejecting projects Various methods NPV Internal rate of return. Net Present Value. Net Present Value. Opportunity Cost of Capital. Net Present Value. Example

kasa
Download Presentation

Finance I

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Finance I October 10 Qinglei Dai for FEUNL, 2006

  2. Topics covered • Capital budgeting: decision-making process for accepting or rejecting projects • Various methods • NPV • Internal rate of return Qinglei Dai for FEUNL, 2006

  3. Net Present Value Net Present Value Opportunity Cost of Capital Qinglei Dai for FEUNL, 2006

  4. Net Present Value Example Q: Suppose we can invest $50 today & receive $60 later today. What is our increase in value? Qinglei Dai for FEUNL, 2006

  5. Net Present Value Example Suppose we can invest $50 today and receive $60 in one year. What is our increase in value given a 10% expected return? Qinglei Dai for FEUNL, 2006

  6. NPV method • The NPV rule: • Value-additivity: Qinglei Dai for FEUNL, 2006

  7. Net Present Value Example You have the opportunity to purchase an office building. You have a tenant lined up that will generate $16,000 per year in cash flows for three years. At the end of three years you anticipate selling the building for $450,000. How much would you be willing to pay for the building? Qinglei Dai for FEUNL, 2006

  8. Net Present Value Example - continued If the building is being offered for sale at a price of $350,000, would you buy the building and what is the added value generated by your purchase and management of the building? Qinglei Dai for FEUNL, 2006

  9. IRR method • Internal Rate of Return (IRR): • Basic IRR rule: Qinglei Dai for FEUNL, 2006

  10. IRR method • Example: suppose a certain project brings a cash flow series of • t=0, c=-200 • t=1, c=100 • t=2, c=100 • t=3, c=100 What is the IRR for the project? Should we accept the project when the discount rate is 20% (30%)? Qinglei Dai for FEUNL, 2006

  11. IRR method • When r=20%, • When r=30% Qinglei Dai for FEUNL, 2006

  12. Problems with IRR • Independent project: • Mutually exclusive projects: • 2 general problems of IRR for both of independent projects and mutually exclusive projects • 2 specific problems of IRR for mutually exclusive projects Qinglei Dai for FEUNL, 2006

  13. Problems with IRR • 1st general problem with IRR: when the cash inflows occur before the cash outflows • Example: • t=0, c=100; t=1, c=-130 Qinglei Dai for FEUNL, 2006

  14. Problems with IRR • investing-type project: • Financing-type project: Qinglei Dai for FEUNL, 2006

  15. Problems with IRR • 2nd general problem with IRR: multiple rates of return with “flip-flop” cash flows • Example: a project with cashflows of (-100, 230, -132) Qinglei Dai for FEUNL, 2006

  16. Problems with IRR • How to solve the above problem? • NPV rule: • Modified IRR (MIRR) Qinglei Dai for FEUNL, 2006

  17. MIRR • Example: cash flow stream (-100, 230, -132), r=14% Qinglei Dai for FEUNL, 2006

  18. Problems with IRR • 1st specific problem with mutually exclusive projects: the scale problem • Example: r=25% Qinglei Dai for FEUNL, 2006

  19. Problems with IRR • How to adjust for this deficiency? • Incremental IRR: Qinglei Dai for FEUNL, 2006

  20. Incremental IRR Qinglei Dai for FEUNL, 2006

  21. Problems with IRR • 2nd specific problem with mutually exclusive projects: timing problem Qinglei Dai for FEUNL, 2006

More Related