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6 Cards in this Set
- Front
- Back
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3 Strategic investment decision techniques
What is my money worth? |
Net Present Value: today's value of future $ - valuable but be careful when estimating inflation, etc.
Paypback period: how fast will I get my money back? Simple and offers some risk perspective, but doesn't traditionally consider NPV. Does not consider what happens after payback period. Internal Rate of Return: gives risk perspective, but not a reliable way to choose between projects How bad it has to be for future $ owed to equal 0? e.g. "if my money is only worth 90% in the future, I make nothing. vs. if it's worth 20%, I make nothing. Latter is safer" |
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Net Present Value (compounding): calculations
TIP: draw out timeline in excel columns |
Compounding in excel: =100*(1.1)^3
*At 10% interest, compounded 3 times, $100 today is worth $100 x 1.1 x 1.1 x 1.1 = $133.10 in the future Discounting in excel: =100/(1.1)^3 *At 10% over 3 periods, $100 owed to us in the future is worth only $100 / 1.1 / 1.1 / 1.1 = $75.13 today |
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Payback period calculations and drawbacks
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Simple but acts like breakeven thinking. Use with caution *or* in conjunction with NPV
= Initial investment / Annual cash flow If annual cash flow varies, tally up years until there is a loss in one year and a gain in the next, then do the same: = "initial investment" of the prior year / "annual cash flow: of the next |
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IRR & uses
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* from this: At 10% over 3 periods, $100 owed to us in the future is worth only $75.13 today
* to this: At ___% over 3 periods, $100 owed to us in the future is worth $0 today In excel, ... |
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NPV in practice - do 5 things
(Must Finance and Strategy Clash? Barwise) |
1. Use the right Base Case -
cost of NOT doing the project. (lose market share / canibalize another product / necessary costs associated w.the new project) 2. Define the project boundaries - As-is base case may become "exit the market" or "necessary change" if we don't do the project 3. Choose the appropriate time horizon Extend through the value of the investment, 10 years out may still have a significant impact 4. Evaluate options What new market opportunities might the investment provide 5. Unbundle the costs and benefits If buying a shop, separate out the property value vs. the shop itself |
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Avoiding gaming - how Smithline (R&D projects) makes better resource decisions
(Sharpe) |
To avoid gaming, consider Smithline's
Buy up, Buy down and Minimal plans when evaluating options for pharma investment. Gave them a better assessment of the *various* options within each investment opportunity |
