Chapter 7

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Chapter 7Net Present Value and Other Investment Criteria7- 2Topics Covered Net Present Value Other Investment Criteria Mutually Exclusive Projects Capital Rationing7- 3Net Present ValueNet Present Value- Present value of cash flows minus initial investmentsOpportunity Cost of Capital- Expected rate of return given up by investing in a project7- 4Net Present ValueExampleSuppose we can invest $50 today & receive $60 later today. What is our increase in value?Initial InvestmentAdded Value$50$10Profit = - $50 + $60 = $107- 5Net Present ValueExampleSuppose we can invest $50 today and receive $60 in one year. What is our increase in value given a 10% expected return?This is the definition of NPVProfit = -50 + $ InvestmentAdded Value$50$ 6Net Present ValueNPV = PV - required investmentNPVCCrtt=++01()NPVCCrCrCrtt=++ +++++01122111()()...()7- 7Net Present ValueTerminologyC= Cash Flowt= time period of the investmentr= opportunity cost of capital The Cash Flow could be positive or negative at any time period7- 8Net Present ValueNet Present Value RuleNet Present Value RuleManagers increase shareholders wealth by accepting all projects that are worth more than they cost.

7- 4 Net Present Value Example Suppose we can invest $50 today & receive $60 later today. What is our increase in value? Initial Investment Added Value

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