1 / 8

Invest and Earn Problem

Invest and Earn Problem. Negative investment cash flow followed by positive return cash flow Evaluate with IRR or NPV Traps Infinite cash flow Truncate it Goes negative later don’t use IRR evaluate how you will handle negative flow in real life and then do it to the cash flow

Angelica
Download Presentation

Invest and Earn Problem

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. Invest and Earn Problem • Negative investment cash flow followed by positive return cash flow • Evaluate with IRR or NPV • Traps • Infinite cash flow • Truncate it • Goes negative later • don’t use IRR • evaluate how you will handle negative flow in real life and then do it to the cash flow • Tweek the IRR by diverting future earnings at the external rate to cover the red ink

  2. One More Trick • The sunk cost problem • Prior to making an investment most companies spend money to develop or ready the opportunity • Example - Oil Industry • Two biggest costs are “finding cost” and “lifting cost”

  3. Example • Bushy Boys Oil spends $200,000,000 dollars a year for 3 years to find the Dead Seal oil field. The exploration data shows that the oil field contains 100,000,000 barrels of recoverable oil. It will cost $50,000,000 over the next year to bribe lobby officials, run a warm fuzzy PR campaign and get the permits to develop the field. It will then cost $400,000,000 to develop the wells to pump the oil field and to develop the pipeline infrastructure to move the oil.

  4. Example Continued • It will cost $11/barrel to lift the oil to the surface and another $1.50/barrel to move it to market. If oil will sell for $25/barrel and the oil field will be pumped down evenly over the next 10 years, can the investment yield a 20% rate of return?

  5. Cash Flow Where is the point of decision? What Kind of Problem is this? Invest and Earn Problem 125,000,000/year -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 -50,000,000 -400,000,000 -200,000,000

  6. Sweeping Into the Pot -$50,000,000 * 0.833 = -$41,665,000 What Did I Forget to Do? -$400,000,000 * 0.6944 = -$277,760,000 $125,000,000 * 4.192 =$524,000,000 * 0.6944 = $363,865,600 Sum Up = $44,440,600 125,000,000/year -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 -50,000,000 -400,000,000 -200,000,000

  7. Wrapping Up What About My $600,000,000 Investment to Find That Oil Field $44,440,600 NPV -3 -2 -1 0 1 2

  8. Sunk Costs Can your decision change whether that cost occurs?

More Related