Finance Video Conferences
IRR Problem: Timing Problem
Both have the same life and require same investment; assume mutually exclusive
Example: NPV and Timelines (Mutually Exclusive)
Compute NPV from summation of 2 against 1 - lay out cash flow for second investment (cost in last year of profit) Apply ie: 7 and 9 years with lowest common multiple - there are other methods too!
NPV and Timelines
Correct comparison is to compare 1 A and 2B i.e.: equipment has different lifespans
Example: Payback Period
Create a cumulative column Recovery between year 2,3 + fraction of transition -Ignores time value of money - not using required rate of return --> fix by discounting each cashflow to present value (undiscounted/1.14^year) -2 year cutoff is not scientifically determined - important how the company determines this -Unfairly penalizes projects with positive cash flows beyond the payback period Can be used to split a tie if NPV is close -> look at investment recovery time, but should not be used in isolation
Calculating the crossover rate
Crossover rate is point where NPVA = NPVB Between 0-10.55, B>A higher NPV 10.55>12.94, A>B Project A can be adopted up until 16.04 After 16.04%, choose neither. If both have -NPV, choose neither! Anything greater than 16% becomes -NPV
Example: NPV
Do not include time 0 cash flow - start at year 1 Gives you percent value of the benefits - be sure to subtract initial year 0: (ROR, all cash flows year 1-end) Choose new submarine - higher NPV You will never go wrong using NPV! Combined NPV -- add cash flows NPVA +NPVB = NPVA&B To solve in excel, you have to subtract the initial cost
Recap
Important to consider incremental cash flows If you're dealing with independent products, any 3 will work. Mutually exclusive, almost 100% NPV -NPV -IRR -Payback Period -Profitability Index -Other
Example: NPV and Timelines (Independent)
Independent - evaluate each on their own merit 1. definitely not the vat: -NPV --> investing -NPV = burn shareholders' money; limited can't do both > the cliffhanger has higher NPV (NPV takes all cashflows into account - superior metric) 2. choose the cliffhanger and chainsaw - these are independent; both will bring in shareholder's money Note: unlimited capital assumption not realistic in industry 3. Shortest payback period: the chainsaw - recover in 2 years vs 4 and 3 years example of -NPV project to pursue: test the market
January effect
Jan monthly returns are positive - bodes well for the rest of the year
Example: Timing Problem
Keep excel at 2 decimals! draw vertical line at desired discount rate - higher NPV = better to invest IRR rule: pick A for higher IRR --> clearly a conflict
Yahoo.com Assessment
Market cap = price * # shares: 1. Apple 2. Microsoft 3. Alphabet (Google) 4. Amazon 5. Berkshire Hathaway --> about 20% of market (7T) Market cap is so representative because the purpose of finance is to maximize shareholder wealth
IRR Problem: multiple sign changes
Massive investment in the beginning and the end: e.g.: nuclear power plant, mining gold; restore/dispose when you're done x axis: different discount rates or cost of capital y axis: NPV NPV profile - constrict graph per blue IRR: NPV = 0 --> cross x axis Conventional: - beginning, + remaining Nonconventional: anything else - as many IRRs as sign changes --> makes it challenging whether to accept
Example: IRR
Mutually exclusive - if you choose one, you cannot choose another If the company invests, annual ROR is 18.5%/year over the next 3 years You can use it to decide on which projects to choose. You can also compute the IRR of a combined project (if they're independent -- add cash flows) Choose deep water fishing - greater IRR
Example: Profitability Index (Benefits to Cost Ratio)
Numerator: %value of benefits (can use NPV excel function) Denominator: cost of investment (year0) >1 --> accept <1 --> reject Use NPV: closely linked to market value of the company
CAPEX (= capital expenditure)
TTM = trailing 12 mo New innovations and how to bring in future revenue --> where and how to spend the money i.e.: Meta spends a lot of money in Metaverse, but it's not clear how successful that is - investors skeptical => low valuation ChatGPT: microsoft invested $10B -->. integrate software bing; openAI
Time Value of Money
Time has a money dimension If you put money in an account for t years at r ROR, you can find compounded FV On avg, US Stock Market SMP500 index - earned about 10% Rule of 72 - how quickly does the money double itself (product of return * time period = approx 72) It's hard to time the market. Prices fluctuate. NPV and IRR: typical company invests -cash flow at initial point and expect benefit to come in the future --> projection forecast depends on life of the project (i.e.: patent = 20) IRR: ROR that sets NPV=0-> what is the ROR if you invest over the life of the project
Rules of Thumb: Independent project Mutually Exclusive
Use NPV, IRR, PI Stick to NPV. IRR or PI may be wrong
US Stock Market Discussion
Wall Street Increasing debt limit - $32B
