Using Net Present Value to Make Investment Decisions

1
Using Net Present Value to Make Investment
Decisions

• Student Presentations
• Net Present Value
• Internal Rate of Return
• Alternative Investment Decision Rules
• Additional Considerations

2
Capital Budgeting Methods

• CFO Survey by Graham and Harvey in 1999 Which
  techniques do you always or almost always use?
• IRR (76)
• NPV (75)
• Hurdle rate (57)
• Payback (57)
• Sensitivity analysis (52)
• Earnings multiple (39)
• Discounted payback period (29)
• Incorporate real options (27)
• Accounting rate of return (20)
• Value-at-Risk (14)
• Profitability index (12)
• Adjusted present value (11)

3
What to Discount

• Only cash flow is relevant
• Estimate cash flows on an incremental basis
• Average vs. incremental payoffs
• Incidental effects
• Include working capital requirements
• Include opportunity costs
• Forget sunk costs
• Beware of allocated overhead costs
• Treat inflation consistently

4
IMCs Fertilizer Project
5
IMCs Fertilizer Project (2)
6
IMCs Fertilizer Project (3)
7
IMCs Fertilizer Project (4)
8
What Discount Rate

• Determining the cost of capital is critical
• Consider yield curve
• Interest rates depend on timing of cash flows
• All investments do not have the same cost of
  capital

9
Next Class

• Risk and Return
• Student presentations
• Capital Asset Pricing Model
• Guest speaker Brian Callaci, Merrill Lynch
  Investment Banking
• Read Chapters 7 and 8 in the text