【正文】 : Stand alone analysis Aswath Damodaran 41 The side benefits ? Assume that the cafe will increase revenues at the book store by $500,000 in year 1, growing at 10% a year for the following 4 years. In addition, assume that the pretax operating margin on these sales is 10%. ? The present value of the added benefits is $115,882. Added to the NPV of the standalone Caf233。Aswath Damodaran 1 Measuring Investment Returns II. Investment Interactions, Options and Remorse… Aswath Damodaran 2 Independent investments are the exception… ? In all of the examples we have used so far, the investments that we have analyzed have stood alone. Thus, our job was a simple one. Assess the expected cash flows on the investment and discount them at the right discount rate. ? In the real world, most investments are not independent. Taking an investment can often mean rejecting another investment at one extreme (mutually exclusive) to being locked in to take an investment in the future (prerequisite). ? More generally, accepting an investment can create side costs for a firm’s existing investments in some cases and benefits for others. Aswath Damodaran 3 Back to the big picture… Aswath Damodaran 4 I. Mutually Exclusive Investments ? Wehave looked at how best to assess a standalone investment and concluded that a good investment will have positive NPV and generate accounting returns (ROC and ROE) and IRR that exceed your costs (capital and equity). ? In some cases, though, firms may have to choose between investments because ? They are mutually exclusive: Taking one investment makes the other one redundant because they both serve the same purpose ? The firm has limited capital and cannot take every good investment (., investments with positive NPV or high IRR). ? Using the two standard discounted cash flow measures, NPV and IRR, can yield different choices when choosing between investments. Aswath Damodaran 5 Comparing Projects with the same (or similar) lives.. ? When paring and choosing between investments with the same lives, we can ? Compute the accounting returns (ROC, ROE) of the investments and pick the one with the higher returns ? Compute the NPV of the investments and pick the one with the higher NPV ? Compute the IRR of the investments and pick the one with the higher IRR ? While it is easy to see why accounting return measures can give different rankings (and choices) than the discounted cash flow approaches, you would expect NPV and IRR to yield consistent results since they are both timeweighted, incremental cash flow return measures. Aswath Damodaran 6 Case 1: IRR versus NPV ? Consider two projects with the following cash flows: Year Project 1 CF Project 2 CF 0 1000 1000 1 800 200 2 1000 300 3 1300 400 4 2200 500 Aswath Damodaran 7 Project’s NPV Profile Aswath Damodaran 8 What do we do now? ? Project 1 has two internal rates of return. The first is %, whereas the second is %. Project 2 has one internal rate of return, about %. ? Why are there two internal rates of return on project 1? ? If your cost of capital is 12%, which investment would you accept? a) Project 1 b) Project 2 Explain. Aswath Damodaran 9 Case 2: NPV versus IRR Cash Flow Investment $ 350,000 $ 1,000,000 Project A Cash Flow Investment Project B NPV = $467,937 IRR= % $ 450,000 $ 600,000 $ 750,000 NPV = $1,358,664 IRR=% $ 10,000,000 $ 3,000,000 $ 3,500,000 $ 4,500,000 $ 5,500,000 Aswath Damodaran 10 Which one would you pick? ? Assume that you can pick only one of these two projects. Your choice will clearly vary depending upon whether you look at NPV or IRR. You have enough money currently on hand to take either. Which one would you pick? a) Project A. It gives me the bigger bang for the buck and more margin for error. b) Project B. It creates more dollar value in my business. If you pick A, what would your biggest concern be? If you pick B, what would your biggest concern be? Aswath Damodaran 11 Capital Rationing, Uncertainty and Choosing a Rule ? If a business has limited access to capital, has a stream of surplus value projects and faces more uncertainty in its project cash flows, it is much more likely to use IRR as its decision rule. Small, highgrowth panies and private businesses are much more likely to use IRR. ? If a business has substantial funds on hand, access to capital, limited surplus value projects, and more certainty on its project cash flows, it is much more likely to use NPV as its decision rule. As firms go public and grow, they are much more likely to gain from using NPV. Aswath Damodaran 12 The sources of capital rationing… C a u s e N u mb e r o f f ir ms P e r c e n t o f to t a l De b t l i m i t i m p o s e d by o u t s i d e a g r e e m e n t 10 1 0 . 7 De b t l i m i t p l a c e d b y m a n a g e m e n t e x te r n a l t o f i r m 3 3 . 2 L i m i t p l a c e d on bo r r o wi n g b y i n t e r n a l m a n a g e m e n t 65 6 9 . 1 R e s t r i c t i v e p o l i c y i m p o s e d o n r e t a i n e d e a r n i n g s 2 2 . 1 M a i n t e n a n c e o f t a r g e t E PS o r P E r a ti o 14 1 4 . 9 Aswath Damodaran 13 An Alternative to IRR with Capital Rationing ? The problem with the NPV rule, when there is capital rationing, is that it is a dollar value. It measures success in absolute terms. ? The NPV can be converted into a relative measure by dividing by the initial investment. This is called the profitability index. ? Profitability Index (PI) = NPV/Initial Investment ? In the example described, the PI of the two projects would have been: ? PI of Project A = $467,937/1,000,000 = % ? PI of Project B = $1,358,664/10,000,000 = % Project A would ha