BOONE BOWLES

HOW DO FIRMS VALUE PROJECTS AND MAKE DECISIONS?

MODULE 4

Agenda

1. What is our go-to decision rule?

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• Can we work on some examples?

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• Are there other decision rules?

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• What if I face resource constraints?

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• How do we forecast and calculate future cash flows?

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• How do we analyze our projections and decision?

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• 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.

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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.

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

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• No increase in NWC.

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• 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