FirstEncounterwithCapitalBudgetingRules外文文献.pptVIP

* * * * * * * CLASS ENDED ON ________________, SESSION ______ * First Encounter WithCapital Budgeting Rules In this chapter, we maintain the assumptions of the previous chapter: We assume perfect markets, so we assume four market features: 1. No differences in opinion. 2. No taxes. 3. No transaction costs. 4. No big sellers/buyers—we have infinitely many clones that can buy or sell. We assume perfect certainty, so we know what the rates of return on every project are. We assume equal rates of returns in each period (year). A capital budgeting rule is a method to decide which projects to take and which to reject. (The name “capital budgeting” is a relic.) NPV 0 is the best rule. Other rules can make some good sense. Some rules that are in common use (especially the payback rule) make much less sense. (You must know why.) * References Corporate Finance: An Introduction (Welch, 2009, Prentice Hall) Chapter 4 Some Background * * Why is NPV the Right Rule? This was covered in #2, where you saw NPV for the first time. In perfect markets under certainty, a positive NPV project is equivalent to an “arbitrage:” money for nothing. (Money for nothing, chicks for free [Dire Straits].) Any alternative rule must simplify back to NPV when financial markets become more and more perfect and uncertainty becomes less and less. It must be a generalization of NPV. Q1: How abundant are positive NPV projects in a perfect world? 4-1 * Separability of Investment and Consumption Q1: You have $100 in cash. The prevailing interest rate is 20% per annum. You have two investment choices: A project that costs $100 and will return $150 next year. Ice Cream—and you love ice cream. Problem: You know you will be dead next year. What should you do? (Should you forego the ice cream for the greater social good and die unhappily?) Q2: Does Value Depend on When You Need Cash? (This is called separation (or separability) of investment and consumption decisions. Actually, in