Corporate finance (1)

11-17
11-3 MARVIN ENTERPRISES DECIDES TO EXPLOIT A NEW TECHNOLOGY—AN EXAMPLE
VALUE OF CURRENT BUSINESS: At price of $7 PV = 24 x 3.5/.20 WINDFALL LOSS: Since price falls to $5 after 5 years, VALUE 420
• But if gold is fairly priced, you do not need to
forecast future gold prices:
• NPV = −investment + PV revenues − PV costs
.1 480 400 800 $105million t t 1 1.10
• Smart investment decisions make more
money than smart financing decisions
• Smart investments are worth more than
they cost
• Positive NPVs
• Firms calculate NPVs by discounting
discounted cash flow (DCF) analysis
• Positive NPVs stem from a comparative
advantage
• Strategic decision making identifies this
comparative advantage; it does not identify growth areas
8 7 8 7.21 8 8.87 8 9.13 NPV ... $1,000 ,000 2 9 10 1.10 1.10 1.10 1.10
11-6
FIGURE 11.1 DEPARTMENT STORE RENTS
11-7
11-1 LOOK FIRST TO MARKET VALUES
11-1 LOOK FIRST TO MARKET VALUES
• Department Store Rents
8 8 8 134 NP V 100 ... 2 1.10 1.10 1.1010 $1,000,000
• [assumes price of property appreciates by 3% a year] • Rental yield = 10 - 3 = 7%
- 96
299 - 72 227
TOTAL VALUE: CURRENT MARKET PRICE:
551 460
11-18
FIGURE 11.3 ALTERNATIVE EXPANSION PLANS
11-19
competitors enter?
11-11
TABLE 11.1 NPV CALCULATION, U.S. COMPANY
11-12
TABLE 11.2 NPV CALCULATION, EUROPEAN COMPANY
11-13
TABLE 11.3 NPV CALCULATION, U.S. COMPANY WITH EUROPEAN COMPETITION
11-14
TABLE 11.4 GARGLE BLASTER INDUSTRY
11-15
FIGURE 11.2 DEMAND FOR GARGLE Fra bibliotekLASTERS
11-16
11-3 MARVIN ENTERPRISES DECIDES TO EXPLOIT A NEW TECHNOLOGY—AN EXAMPLE
10
11-9
11-1 LOOK FIRST TO MARKET VALUES
• Does Project Have Positive NPVs?
• Rents
• Profits that more than cover the cost of capital • NPV = PV (rents) • Rents come only when you have a better
product, lower costs, or some other competitive edge
• Sooner or later competition is likely to
eliminate rents
11-10
11-1 LOOK FIRST TO MARKET VALUES
• Competitive Advantage
• Value of Gargle Blaster Investment
6 3 10 NP V new plant 100 10 t 1.2 1.25 $299 million 1 Change P V exist ingplant 24 $72 million t 1. 2 Net benefit 299 72 $227 million
ask whether it is worth more to you than to others
11-4
11-1 LOOK FIRST TO MARKET VALUES
• Don’t assume other firms will watch
passively
• Ask
• How long a lead do I have over my rivals?
• Example
• King Solomon’s mine
Investment = $400 million
Life
Production Production cost
= 10 years
= .1 million oz. a year = $480 per oz.
Current gold price = $800 per oz.
Chapter
11
INVESTMENT, STRATEGY, AND ECONOMIC RENTS
Brealey, Myers, and Allen
Principles of Corporate Finance
11th Global Edition
McGraw-Hill Education
11-1 LOOK FIRST TO MARKET VALUES
What will happen to prices when that lead disappears?
• In the meantime how will rivals react to my
move? Will they cut prices or imitate my product?
11-5
Discount rate = 10%
11-8
11-1 LOOK FIRST TO MARKET VALUES
• Example, continued
• If the gold price is forecasted to rise by 5% p.a.:
NPV 400 .10(840 480 ) .10(882 480 ) ..... $70 million 1.10 1.10 2
forecast cash flows
11-2
11-1 LOOK FIRST TO MARKET VALUES
• Projects may appear to have positive NPVs
due to forecasting errors
• Some acquisitions result from error in a
11-3
11-1 LOOK FIRST TO MARKET VALUES
• Don’t make investment decisions on the
basis of errors in DCF analysis
• Start with the market price of the asset and
Loss = - 24 x (2 / .20) x (1 / 1.20)5
VALUE OF NEW INVESTMENT: Rent gained on new investment = 100 x 1 for 5 years = Rent lost on old investment = - 24 x 1 for 5 years =
• Proposal to manufacture specialty chemicals
• Raw materials were commodity chemicals
imported from Europe
• Finished product was exported to Europe • High early profits, but what happens when