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BOONE BOWLES

HOW DO FIRMS VALUE PROJECTS AND MAKE DECISIONS?

MODULE 4

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Agenda

  1. What is our go-to decision rule?

  • Can we work on some examples?

  • Are there other decision rules?

  • What if I face resource constraints?

  • How do we forecast and calculate future cash flows?

  • How do we analyze our projections and decision?

  • A final thought.

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The NPV rule is our go-to decision rule!

Decision Rule

  • When choosing among alternatives, take the one with the highest NPV.
  • When evaluating a single project, accept if NPV > 0.

Interpretation

  • NPV>0→ creates value for shareholders.
  • NPV=0→ break-even (investor is indifferent).
  • NPV<0→ destroys value; reject.

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  • New equipment will be installed at the end of the first year, depreciated using SL depreciation for five years, and assume zero salvage value.

  • New equipment will be installed with up front cost of $7.5 million.

  • No increase in NWC.

  • Discount rate 12%.

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What did we learn here?

  1. What is out go-to decision rule?
    • NPV
  2. Can we work on some examples?
    • Yes, and we did.
  3. Are there other decision rules?
    • Yes, but NPV is the best.
  4. What if I face resource constraints?
    • Use a Profitability Index.
  5. How do we forecast and calculate future cash flows?
    • We do it carefully.
  6. How do we analyze our projections and decision?
    • BE, Sensitivity, and Scenario Analysis.
  7. A final thought.
    • Discount rates will complete the story.

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WHERE BUSINESS MEETS LEADERSHIP