ADMN 3116: Financial Management 1 Lecture 4: Basics of Investments

1. ADMN 3116: Financial Management 1 Lecture 4: Basics of Investments Anton Miglo Fall 2014

2. 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

3. 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?

4. Net Present Value -300,000 520,0000 20,000 20,000

5. NPV Example How does Eurotunnel Compare?

7. Some concepts • Cash flows vs. profits • Incremental benefits • Sunk Costs • Mutually exclusive projects

8. Cash Flows vs Profits

9. 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

10. Investment criteria in use

11. 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.

12. 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

13. NPV and IRR in Excel

14. Mutually exclusive projects