The Competing Investments Problem

1. 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

2. 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?

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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?)

11. 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

12. 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.