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

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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

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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

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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

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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

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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

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Managements 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.