chap_6.pptVIP

Topics Covered 6.1 Net Present Value 6.2 Other Investment Criteria 6.3 Mutually Exclusive Projects 6.4 Capital Rationing The case of Kaufman Company Kaufman company is a famous propety company, its financial analyst Lousis is considering suggesting the company to spend $85,000 in a land. She is sure that this land will be worth $91,000 in the next year. There is no doubt that company will gain $6,000.If the bank rate is 10%,should the company invest in this land? 6.1 Net Present Value（P137） Example: Suppose you come across a vacant lot that you can buy for $50000. Your real estate adviser thinks there will be a shortage of office space a year from now and that an office building will fetch $400000. The total cost of buying the land and constructing the building would be $350000. Assume that the rate of interest on U.S. government securities is 7% per year. Should you carry on this project? First, you should calculate the PV of this project: Second, calculate the NPV of the project: NPV = PV - required investment = =-350000+374000=24000 That is, your office development is worth than its costs—it makes a net contribution to value and increases your wealth. A comment on Risk and PV However, can you be sure that the office building will be sold for $400000 a year from now? A basic financial principle: A risky dollar is worth less than a safe one. But why? Not all investments are equally risky! Suppose you believe the project is as risky as investment in the stock market and that stocks are forecasted to return 12%. Then 12% becomes the opportunity cost of capital. Now recomputer NPV: Valuing Long-lived Projects Now you have some bad news about your office building venture. The contractor says that construction will take two years instead of one and requests payment on the following schedule: 1. A $100,000 down payment now. (Note: The land, worth $50,000, must also be committed now.) 2. A $100,000 progress payment after