Financial Management: Principles & Applications

Transcript:Financial Management: Principles & Applications:
Financial Management: Principles & Applications Thirteenth Edition Chapter 11 Investment Decision Criteria Copyright © 2018, 2014, 2011 Pearson Education, Inc. All Rights Reserved Learning Objectives (1 of 2) Understand how to identify the sources and types of profitable investment opportunities. Evaluate investment opportunities using net present value and describe why net present value is the best measure to use. Learning Objectives (2 of 2) Use the profitability index, internal rate of return, and payback criteria to evaluate investment opportunities. Understand current business practice with respect to the use of capital-budgeting criteria. Principles Applied in This Chapter Principle 1: Money Has a Time Value. Principle 2: There is a Risk-Return Tradeoff. Principle 3: Cash Flows Are the Source of Value. Principle 5: Individuals Respond to Incentives. 11.1 AN OVERVIEW OF CAPITAL BUDGETING Disney’s Capital Budgeting Decision: Three Important Lessons (1 of 2) Disney’s decision to invest $17.5 million to build Disneyland park in California in 1955 is an example of a major capital budgeting decision. How did this decision impact Disney? What important lessons can we learn from Disney theme park story? Disney’s Capital Budgeting Decision: Three Important Lessons (2 of 2) Capital budgeting decisions are critical in defining a company’s business Very large investments frequently consist of smaller investment decisions that define a business strategy Successful investment decisions lead to the development of managerial expertise and capabilities that influence the firm’s choice of future investments. The Typical Capital—Budgeting Process Phase I: The firm’s management identifies promising investment opportunities. Phase II: The investment opportunity’s value-creating potential-what some refer to as its value proposition-is thoroughly evaluated. Types of Capital Investment Projects Revenue enhancing Investments (such as introducing a new product line), Cost-reducing investments (such as replacing old equipment with a more efficient equipment), and Mandatory investments that are a result of government mandates (such as investments to meet safety and environmental regulations) 11.2 NET PRESENT VALUE Net Present Value The net present value (NPV) is the difference between the present value of cash inflows and the cash outflows. NPV estimates the amount of wealth that the project creates. Decision Criteria: Investment projects should be accepted if the NPV of the project is positive and should be rejected if the NPV is negative. Calculating an Investment’s NPV (1 of 2) Cost of making the investment = Initial cash flow (this is typically a cash outflow, taking on a negative value) Present value of