02 Present Value and The OpportunityCost of Capital

1、Principles of Corporate FinanceSeventh EditionRichard A. Brealey Stewart C. MyersSlides byMatthew WillChapter 2McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Present Value and The Opportunity Cost of Capital2- 2McGraw Hill/IrwinCopyright 2003 by The McGraw-Hil

2、l Companies, Inc. All rights reserved Topics Coveredw Present Valuew Net Present Valuew NPV Rulew ROR Rulew Opportunity Cost of Capitalw Managers and the Interests of Shareholders2- 3McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Present ValuePresent ValueValu

3、e today of a future cash flow.Discount RateInterest rate used to compute present values of future cash flows.Discount FactorPresent value of a $1 future payment.2- 4McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Present Value1factordiscount =PVPV=ValuePresent

4、C2- 5McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Present ValueDiscount Factor = DF = PV of $1Discount Factors can be used to compute the present value of any cash flow.DFrt11()2- 6McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights

5、 reserved Valuing an Office BuildingStep 1: Forecast cash flowsCost of building = C0 = 350Sale price in Year 1 = C1 = 400Step 2: Estimate opportunity cost of capitalIf equally risky investments in the capital marketoffer a return of 7%, thenCost of capital = r = 7%2- 7McGraw Hill/IrwinCopyright 2003

6、 by The McGraw-Hill Companies, Inc. All rights reserved Valuing an Office BuildingStep 3: Discount future cash flowsStep 4: Go ahead if PV of payoff exceeds investment374)07.1 (400)1 (1rCPV24374350NPV2- 8McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Net Prese

7、nt ValuerC1C=NPVinvestment required-PV=NPV102- 9McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Risk and Present Valuew Higher risk projects require a higher rate of returnw Higher required rates of return cause lower PVs374.071400PV7%at $400 C of PV12- 10McGra

8、w Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Risk and Present Value374.071400PV7%at $400 C of PV1357.121400PV12%at $400 C of PV12- 11McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Rate of Return Rulew Accept investments tha

9、t offer rates of return in excess of their opportunity cost of capital2- 12McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Rate of Return Rulew Accept investments that offer rates of return in excess of their opportunity cost of capitalExampleIn the project lis

10、ted below, the foregone investment opportunity is 12%. Should we do the project?14.3%or .143350,000350,000400,000investmentprofitReturn2- 13McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Net Present Value Rulew Accept investments that have positive net present

11、 value2- 14McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Net Present Value Rulew Accept investments that have positive net present valueExampleSuppose we can invest $50 today and receive $60 in one year. Should we accept the project given a 10% expected retur

12、n?55. 4$1.1060+-50=NPV2- 15McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Opportunity Cost of CapitalExampleYou may invest $100,000 today. Depending on the state of the economy, you may get one of three possible cash payoffs:140,000110,000$80,000PayoffBoomNorm

13、alSlumpEconomy000,110$3000,140000,110000,80C payoff Expected12- 16McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Opportunity Cost of CapitalExample - continuedThe stock is trading for $95.65. Next years price, given a normal economy, is forecast at $1102- 17Mc

14、Graw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Opportunity Cost of CapitalExample - continuedThe stocks expected payoff leads to an expected return.15%or 15.65.9565.95110profit expectedreturn Expectedinvestment2- 18McGraw Hill/IrwinCopyright 2003 by The McGraw-H

15、ill Companies, Inc. All rights reserved Opportunity Cost of CapitalExample - continuedDiscounting the expected payoff at the expected return leads to the PV of the project650,95$1.15110,000PV2- 19McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Investment vs. Co

16、nsumptionw Some people prefer to consume now. Some prefer to invest now and consume later. Borrowing and lending allows us to reconcile these opposing desires which may exist within the firms shareholders.2- 20McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Inv

17、estment vs. Consumption A n B n100806040202020406080100income in period 0income in period 1Some investors will prefer Aand others B2- 21McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Investment vs. ConsumptionThe grasshopper (G) wants to consume now. The ant (

18、A) wants to wait. But each is happy to invest. A prefers to invest 14%, moving up the red arrow, rather than at the 7% interest rate. G invests and then borrows at 7%, thereby transforming $100 into $106.54 of immediate consumption. Because of the investment, G has $114 next year to pay off the loan

19、. The investments NPV is $106.54-100 = +6.542- 22McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Investment vs. ConsumptionwThe grasshopper (G) wants to consume now. The ant (A) wants to wait. But each is happy to invest. A prefers to invest 14%, moving up the red arrow, rather than at the 7% interest rate. G invests and then borrows at 7%, thereby transforming $100 into $106.54 of immed