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ADMN 3116: Financial Management 1 Lecture 4: Basics of Investments. Anton Miglo Fall 2014. Topics. Net present value rule Internal rate of return Mutually exclusive projects Capital rationing Cash flows vs. profits NPV and firm’s value Goals of corporations and agency problems
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ADMN 3116: Financial Management 1 Lecture 4: Basics of Investments Anton Miglo Fall 2014
Topics • Net present value rule • Internal rate of return • Mutually exclusive projects • Capital rationing • Cash flows vs. profits • NPV and firm’s value • Goals of corporations and agency problems • Excel: NPV, IRR • Additional readings: B ch. 2,4,5
Net Present Value You have an investment project available (for example, the opportunity to purchase an office building). It cost $300,000. It will generate $20,000 per year in cash flows for three years. At the end of three years you anticipate selling the assets (building) for $500,000. Would you invest in the project?
Net Present Value -300,000 520,0000 20,000 20,000
NPV Example How does Eurotunnel Compare?
Some concepts • Cash flows vs. profits • Incremental benefits • Sunk Costs • Mutually exclusive projects
Internal rate of return • IRR is the discount rate for which the NPV = 0. • The project should be accepted if IRR is greater than the discount rate
NPV and Firm’s Value • The NPV of a project shows by how much the firm’s value will change after the project is accepted.
Firm’s Value and The Agency Problem • In 1992, Dennis Koslowski’s (TYCO)announced that.. perks such as country-club memberships and executive dining rooms are taboo • Early 2000s revelations of asset embezzlement • $17,100 traveling toilet box • $15,000 dog umbrella stand • $16.8 million apartment on Fifth Avenue • $3 million in renovations • $11 million in furnishings • $7 million apartment on Park Avenue for his former wife. • A $72,000 fee to Germán Frers, a yacht maker • A $6,300 sewing basket • A $6,000 shower curtain • $5,960 for two sets of sheets • A $2,900 set of coat hangers • A $2,200 gilt metal wastebasket • and a $445 pincushion