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Chapter 5 -- Measuring Investment Value: You Can Trust NPV

Chapter 5 -- Measuring Investment Value: You Can Trust NPV. Goals for this chapter: Be able to calculate the NPV for projects with: Year-end cash flows Midyear cash flows Mixed year-end and midyear cash flows Understand the meaning of NPV

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Chapter 5 -- Measuring Investment Value: You Can Trust NPV

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  1. Chapter 5 -- Measuring Investment Value: You Can Trust NPV • Goals for this chapter: • Be able to calculate the NPV for projects with: • Year-end cash flows • Midyear cash flows • Mixed year-end and midyear cash flows • Understand the meaning of NPV • Understand management role in conveying information to the market

  2. NPV of Year End Cash Flows • Calculate the net present value of a project with year end cash flows. • Problems 5-1 -- Even cash flows • Problems 5-4 -- Declining cash flows • Problems 5-5 -- Uneven cash flows • Problems 5-7 -- Overhaul cost and even cash flows • Problems 5-16 -- Growing cash flows • On all of these problems you can use the NPV function to calculate the present value

  3. Overview of the Calculation of NPV • On all NPV problems you must • First estimate and then calculate the cash flows for each year • Remember inflows are positive and outflows are negative • There are three stages of a projects life • The acquisition stage • The operating stage • The disposition stage • Once the cash flows for each period are estimated they need to be discounted to present by multiplying by 1 / (1 + i )n

  4. What Creates a Positive Net Present Value? • How do the following interact to create a positive net present value? • Market Imperfections • Strategy • Competitive Advantage • Economic profit

  5. Meaning of Net Present Value • NPV measures wealth created regardless of whether or not the company includes debt in its capital structure. • Tables 5-2 and 5-3 • NPV measures wealth created even in the presence of income taxes. • Table 5-4 • The presence of risk changes a NPV to an expected NPV with ranges

  6. Management’s Role in Helping the Market Assess the NPV of the Firm • Management must practice due diligence in estimating the cash flows and NPVs and then keep the shareholders informed so that the market price will equal the intrinsic value over time. • If they do not, difficulties begin when investors are not fully informed and the market price is substantially different from the intrinsic value.

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