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8 Cards in this Set
- Front
- Back
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What is the Net Present Value of a project? |
Present Value sum of all future cash flows. Also, PV (benefits) - PV (costs) (p 59) |
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What is a real option? |
Real options are delayed decisions that are incorporated into investment decisions. (Alan) Real options are actual options (in the sense of "choices") that a business may gain by undertaking certain endeavors. For example, by investing in a particular project, a company may have the real option of expanding, downsizing or abandoning other projects in the future. Other examples of real options may be opportunities for R&D, M&A and licensing. (Investopedia) |
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What are other valuation approaches (i.e., other than NPV)? |
Payback period Internal rate of return (IRR) |
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Payback Period |
The time it takes for cumulative earnings of a project to become positive. (Eg, number of years it takes to receive the initial cost of capital) |
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What is a critique of payback period as a valuation approach? What is it good for? |
Critiques: - ignores time value of money (unless discounted) - doesn't consider cash flows beyond the payback period, which means it is a poor measure of profitability It is good as a measure of project liquidity |
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Internal rate of return |
It is the discount rate that makes PV (inflows) = PV (outflows) -- that is, NPV = 0 IRR > CoC, accept IRR < CoC, reject |
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What is a critique of IRR as a valuation approach? What is it good for? |
Not accurate: - there can be multiple IRRs - A higher IRR doesn't mean better (probably just paid faster) |
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Calculate NPV |
Adjust differences btw incremental earnings and cash flow: Sales - COGS = Gross Profit Gross Profit - SGA - R&D - Depreciation = EBIT EBIT * tax = Unlevered Net Income Adjust: Plus: Depreciation Less: CapEx Less: Increase in NWC (i.e., Current Assets - CL) |
