公司金融课件 7.Investment Criteria.docVIP

PROJECT EVALUATION Project Evaluation: To identify investment opportunities worth more to the firm than they cost to acquire.(We also call it capital budget, as it involves in fixed asset planning and management.) Objectives: Learn to use Net Present Value methodology to evaluate investments in assets. Consider the strengths and weaknesses of several other approaches to evaluating a capital investment opportunity, specifically: Payback period Internal rate of return Profitability index NET PRESENT VALUE: Example 1: There is an opportunity to build a small office building for $700,000. You have an interested party who wishes to rent the building for 3 years, at a net annual cost of $33,000. At the end of the third year, the building will be sold for $800,000. Is this an acceptable investment? Step 1: Forecast the cash flows. Step 2: Determine the appropriate cost of capital. Step 3: Discount the future cash flows to determine the Present Value. Step 4: Calculate the Net Present Value by subtracting the investment cost. Step 5: Proceed if NPV ( 0 Continue the example: Example 2 Your company is drilling a well to provide naturally carbonated water to a bottling company. The well will cost $9 million to bring into production. Annual cash flow from the production will be $1.3 million for the next 15 years, before the well is depleted. The firm will have to spend $1.1 million to clean up the site. The CEO has determined that the opportunity cost for a project with this level of risk is 10.5%. Is the project worth pursuing? PAYBACK: Example: PROJECT 1 2 3 Cash Flow Investment -2,000 -2,000 -2,000 (t0) Year 1 500 500 1,800 Year 2 500 1,800 500 Year 3 5,000 0 0 Project 1 clearly has a superior NPV, but Projects 2 3 have payback periods of less than two years and would be acceptable with this approach. Project 2 even has a negative NPV so would reduce the value of the asset. INTERNAL RATE OF RETU