Professional Documents
Culture Documents
Chapter 3
Financial Decision
Making and the Law
of One Price
Present Value
and the NPV Decision Rule
The net present value (NPV) of a project or
investment is the difference between the
present value of its benefits and the present
value of its costs.
Net Present Value
NPV PV (Benefits) PV (Costs)
NPV PV (All project cash flows)
Separation Principle
We can evaluate the NPV of an investment decision
separately from the decision the firm makes
regarding how to finance the investment or any
other security transactions the firm is considering.
Chapter 4
The Time Value
of Money
The Timeline
A timeline is a linear representation of the
timing of potential cash flows.
The Timeline
Differentiate between two types of cash flows
Inflows are positive cash flows.
Outflows are negative cash flows, which are
indicated with a (minus) sign.
The Timeline
Assume that you are lending $10,000 today and that the loan will be
repaid in two annual $6,000 payments.
Timelines can represent cash flows that take place at the end of any time
period a month, a week, a day, etc.
Chapter 7
Investment
Decision Rules
In other cases, the IRR rule may disagree with the NPV rule and
thus be incorrect.
Situations where the IRR rule and NPV rule may be in conflict:
Delayed Investments
Nonexistent IRR
Multiple IRRs
The fact that the IRR exceeds the cost of capital for
both projects does not imply that either project has a
positive NPV.
When individual projects have different costs of
capital, it is not obvious which cost of capital the
incremental IRR should be compared to.
IESEG FINANCIAL MANAGEMENT S2-2014/2015
Project Selection
with Resource Constraints
Evaluation of Projects with Different Resource
Constraints
The profitability index can be used to identify the
optimal combination of projects to undertake.
Profitability Index
Value Created
NPV
Resource Consumed
Resource Consumed
Chapter 8
Fundamentals of
Capital Budgeting
Forecasting Earnings
Capital Budget
Lists the investments that a company plans
to undertake
Capital Budgeting
Process used to analyze alternate investments and
decide which ones to accept
Forecasting Earnings
Incremental Earnings
The amount by which the firms earnings are
expected to change as a result of the investment
decision
Interest Expense
In capital budgeting decisions, interest
expense is typically not included. The rationale
is that the project should be judged on its
own, not on how it will be financed.
Taxes
Marginal Corporate Tax Rate
The tax rate on the marginal or incremental dollar of
pre-tax income. Note: A negative tax is equal to a
tax credit.
Income Tax EBIT c
1
(1 r )t
t year discount factor
Sensitivity Analysis
Sensitivity Analysis shows how the NPV varies
with a change in one of the assumptions,
holding the other assumptions constant.
Which aspects of the project are more critical
when managing the project
Chapter 9
Valuing Stocks