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Like project A, project C also costs $1 million to set up, and it will pay back $1,600,000. For both A and C, the firm will earn $800,000 per year for two years starting one year after setup. However, C costs $500,000 initially and the other $500,000 need only be paid at the termination of the project (it may be a cleanup cost, for example). Project A requires the initial outlay all at once at the outset. Which is the better project, A or C? Of projects A, B, and C, which project(s) should be undertaken? We should make the project decision only after analyzing each project‟s NPV. Exhibit 6.5 tabulates each project‟s cash flows, discounted cash flows, and NPVs. The NPVs of projects A, B, and C, are, respectively, $222,222, -$151,235, and $375,000. Project C has the highest NPV. Therefore, if only one project can be selected, it should be project C. If more than one project can be undertaken, then both A and C should be selected since they both have positive NPVs. Project B should be rejected since it has a negative NPV and would therefore destroy wealth. Exhibit 6.5 Cash flows and discounted cash flows for three alternative projects (thousands).
It makes sense that project C should have the highest NPV, since its cash outflows are deferred relative to the other projects and its cash inflows are early. Project B, alternatively, has all costs up front, but its cash inflows are deferred. Suppose a project has positive NPV, but the NPV is small, say, only a few hundred dollars. The firm should nevertheless undertake that project if there are no alternative projects with higher NPVs. The reason is that a firm‟s value is increased every time it undertakes a positive-NPV project. The firm‟s value increases by the amount of the project NPV. A small NPV, as long as it is positive, is net of all input costs and financing costs. So, even if the NPV is low, the project covers all its costs and provides additional returns. If accepting the small-NPV project does not preclude the undertaking of a higher-NPV project, then it is the best thing to do. A firm that rejects a positive-NPV project is rejecting wealth. Of course, this does not mean a firm should jump headlong into any project that at the moment appears likely to provide positive NPV. Future potential projects should be considered as well, and they should be evaluated as potential alternatives. The projects, current or future, that have the highest NPVs should be the projects accepted. For maximum wealth-creation efficiency, the firm‟s managerial resources should be committed toward undertaking maximum-NPV projects. Outsourcing and the Build/Buy Decision Firms are often faced with the question of whether it is better to undertake a particular function internally or, alternatively, outsource the function to an external entity. For example, should an online retailer undertake the fulfillment process of packaging and shipping itself, or should it subcontract the job to an outside company? Similarly, firms are often faced with the dilemma of whether it is better to build enterprise software or other productive assets in-house, or alternatively buy such assets readymade from outside vendors. While the issues of core competencies, strategic fit, and managerial capacity must also be considered when making such decisions, an NPV analysis can help organize the issues and can help point the firm toward the optimal path. The alternative with the highest NPV creates the most value for the company. The Discount Rate At what rate should cash flows be discounted to compute net present values? In most cases, the appropriate rate is the firm‟s cost of funds for the project. That is, if the firm secures financing for the project by borrowing from a bank, the after-tax interest rate should be used to discount cash flows. If the firm obtains funds by selling stock, then an equity financing rate should be applied. If the financing combines debt and equity, then the appropriate discount rate would be an average of the debt rate and the equity rate. Cost of Debt Financing
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Table of Contents Title Page Copyri
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Chapter 6 - Planning Capital Expend
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For Further Reading Part IV - Manag
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Successful Postmerger Implementatio
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This book is printed on acid-free p
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Syllabus How Chapter Topics in This
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Some of these experts are full-time
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About the Contributors Richard T. B
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Advances in Quantitative Analysis o
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enterprise development. Dr. Zachara
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The left side shows Nutrimin‟s in
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Gail, let‟s go over this balance
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Gail, do you have any questions abo
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11. Not all expenses are cash outfl
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Financial Statements: Who Uses Them
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profitability to keep investing for
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Financial Accounting Standards It i
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Downloadable Resources for this cha
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Next, we explain each of these thre
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liquidity. Or, more simply, achievi
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If these ratios are seriously defic
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The debt-to-equity ratio is evaluat
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year 1 to year 3. The net effect wa
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to rate of return on the equity. Th
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Other types of comparisons of finan
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income/sales), asset turnover (sale
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successful businesspeople should ha
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More than a decade ago, a special c
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companies is used for illustration.
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The identification of nonrecurring
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The Dow Chemical single-step income
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is a pretax measure, but income fro
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Sources: Companies‟ annual report
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Exhibit 3.11 Examples of discontinu
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amortization purposes, the Company
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Examples of nonrecurring items disc
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During Fiscal 2006, inventory quant
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The nonrecurring items of Boston Sc
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The disclosure presented earlier in
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gains or losses that appear as part
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ecurring as for Kimberly-Clark, the
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Summarizing Nonrecurring Items and
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This example of using the SEB works
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Exhibit 3.27 Other income (expense)
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Source: Pfizer, Inc., annual report
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Exhibit 3.30 Acquisitions note: Pfi
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Source: Pfizer, Inc., annual report
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Exhibit 3.33 Cost-reduction initiat
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Exhibit 3.36 Share-based payment no
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The Pfizer Worksheet Analysis: Down
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Some Further Points on the Pfizer W
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• It is common to treat items as
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FedEx Corporation (2007) First Sola
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1 The American Institute of Certifi
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28 These alternative translation me
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If you need some instruction in Exc
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To solve using Excel, open your Exc
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As you can see from the previous ex
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C6 = 5 • Now enter the “=” si
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Ordinary Annuity An ordinary annuit
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To confirm that the number of payme
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The FV of this first payment into t
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Exhibit 4.15 Finding the future val
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Exhibit 4.18 Finding the present va
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From Exhibit 4.20, we see that as t
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Exhibit 4.22 Amortization schedule
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Exhibit 4.25 Regular cash flows wit
Page 144: Internet Links For Further Reading
Page 148 and 149: Investors who are risk averse will
Page 150 and 151: considering the risk of a single as
Page 152 and 153: Portfolio Risk Stand-alone risk is
Page 154 and 155: In spite of unique or diversifiable
Page 156 and 157: If a particular stock is highly sus
Page 158 and 159: The formula tells us that, to begin
Page 160 and 161: for the entire market of stocks sin
Page 162 and 163: The dividend per share for preferre
Page 164 and 165: If you are able to determine the cu
Page 166 and 167: Debt finance is the lower-cost meth
Page 168 and 169: We don‟t observe many firms whose
Page 170 and 171: Capital Structure in Practice Finan
Page 172 and 173: are able to observe regularities in
Page 174 and 175: dividends and capital gains. We wil
Page 176 and 177: where EBIT is earnings before inter
Page 178 and 179: Since long-term debt holders have a
Page 180 and 181: accept more investment projects. Re
Page 184 and 185: A beer company is considering build
Page 186 and 187: accounts receivable, and tabulates
Page 188 and 189: profit by the tax rate determines t
Page 190 and 191: Accounting profit often mixes varia
Page 192 and 193: The concept that future cash flows
Page 196 and 197: The after-tax interest rate is the
Page 198 and 199: equal mix of debt and equity, its d
Page 200 and 201: The payback period rule stipulates
Page 202 and 203: The IRR rule is appealing in that i
Page 204 and 205: complete with its real options is g
Page 208 and 209: What does it matter that one invest
Page 210 and 211: Exhibit 7.3 Time line in dollars an
Page 212 and 213: There are a number of countries in
Page 214 and 215: eturn of 10% on its investments in
Page 216 and 217: Exhibit 7.12 Summary of exchange ra
Page 218 and 219: and so will the value of the liabil
Page 220 and 221: Source: CIA, World Factbook, availa
Page 222 and 223: Exhibit 7.18 Net present value of c
Page 224 and 225: equired interest payments to be pai
Page 226 and 227: So if the assistant treasurer was r
Page 228 and 229: This theory is far from perfect, as
Page 230 and 231: The Consulting Firm Jennifer, Jean,
Page 232 and 233: part by a statute, the Uniform Limi
Page 234 and 235: formation in Delaware (or any state
Page 236 and 237: purpose of requiring qualification.
Page 238 and 239: Phil‟s death may terminate the bu
Page 240 and 241: the transfer. This means that if Br
Page 242 and 243: These rules extend to tort liabilit
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In the absence of a meeting, stockh
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A more detailed discussion on the b
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Partnerships If possible, the resul
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associated with this arrangement ar
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Partnerships are also not separate
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For most start-up businesses, howev
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form, even at the risk of some unli
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likely that our consultants will be
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Thus, the corporation and LLC, with
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It is not possible to fully describ
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usiness corporation for all purpose
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a cash-basis taxpayer to be taxed a
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The Tax Reform Act of 1986 substant
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limit is the product of the value o
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he would have spent anyway. In fact
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protect Brad from the scenario of h
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paying for the privilege. If the st
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The second tax scenario attaches to
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include that nullity in his taxable
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then the capital gain to be taxed h
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Most relevant to Morris is Section
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To begin with, the ESOP will have t
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general partner of a limited partne
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small businesses) is also subject t
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oth Lisa and Brad would be free to
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Assume that a limited liability com
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corporations, and had been audited
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There is plenty of blame from the c
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• An important study about top ma
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• The federal government made at
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$79.7 million for other services, a
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Budgets offer a variety of benefits
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determine the impact of specific pr
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Exhibit 11.2 Budget variance report
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udget, we just add more to it next
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income statement. The financial bud
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For a manufacturing company, cost o
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C&G‟s Gift Shop has a policy to m
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Meeting cash obligations as they co
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was unusually low, say, due to the
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A fixed budget, sometimes called a
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A large part of the budget selling
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• Centralized resource allocation
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Merewitz, Leonard, and Stephen H. S
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This chapter starts with a discussi
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Interestingly the numbers for quart
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Exhibit 12.4 Scenarion analysis.
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Pitfalls Although this analytic tec
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Exhibit 12.6 Variable cost element
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Variable Cost as a Function of Outp
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If scenario 2 yields a lower profit
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Microsoft certainly does not price
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If it is determined that dumping ha
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Leaving government agencies and not
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transaction processing. Each proces
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Exhibit 13.3 E-commerce transaction
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To summarize the analysis, the busi
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Capacity costs are probably the mos
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which it was, but for the inventory
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They called this strategic cost man
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A closer study, however, revealed s
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the benefits of business planning.
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The last type of plan is called a d
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The Business Plan We will progress
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Hook the Reader That means having t
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Industry The goal of this section i
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upscale suburban client who wants p
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Company and Product Description Com
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Exhibit 14.8 shows the competitive
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Exhibit 14.9a Advertising schedule.
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Scope of Operations What is the pro
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Development Time Line A development
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By law, most organization types req
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As mentioned in the development pla
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that can be depreciated, you should
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1 Special thanks to Matt Feczko, Mi
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For better or worse, the business e
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Leeson bet and lost. Japanese stock
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Between February and April 1994, Da
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LTCM could be picky when it came to
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An investor who wished to invest in
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Similarly, the swaps market has rev
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speculator would suffer losses equa
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American manufacturer will suffer l
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The ease with which futures facilit
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Exhibit 15.1 Call option payoff dia
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Exhibit 15.2 Payoff diagram for a w
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Notice that the put option payoff r
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Bank, owns a large block of NASDAQ
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can be tailored so that the money r
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Finally, the last step is to choose
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3 Fischer Black, who co-invented th
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not include assets that the firm ha
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Thus, a business valuation will usu
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Negative • Acme is highly depende
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Exhibit 16.3 Acme Manufacturing, In
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Profitability ratios reflect the re
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When we talk about the value of a b
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This example illustrates that with
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Income Approach: Discounted Cash Fl
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Exhibit 16.5 Acme Manufacturing, In
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Victoria explains that the second p
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Victoria analyzes Acme‟s audited
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In summary, the discounted cash flo
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Adjustment for Illiquidity As previ
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51% position sells for a higher pri
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examples. The proper application of
Page 471 and 472:
The subject of this chapter is grow
Page 473 and 474:
Finally, an acquisition can be effe
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M&A activity has been the focus of
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companies continue to make the same
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equals was taking on a distinctive
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Anatomy of a Successful Acquirer: T
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employees kept their original jobs
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where ΔCF t is the incremental cas
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where it‟s ultimately buried. Suc
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The following example summarizes th
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make sure that you are at least awa
Page 493 and 494:
acquisition, there is no immediate
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its vascular business, which was so
Page 497 and 498:
While all employees should be part
Page 499 and 500:
makes strategic and financial sense
Page 501 and 502:
Bhagat, Sanjai, Ming Dong, David Hi
Page 505 and 506:
The 2008 financial crisis underscor
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Source: Plunkett’s Outsourcing &
Page 509 and 510:
To summarize: Trends • Large numb
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Companies are becoming increasingly
Page 513 and 514:
What steps should a company follow
Page 515 and 516:
• Results of meetings with vendor
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• Breach of contract and remedies
Page 519 and 520:
Assuming the project or service rev
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The answer is: profits. The company
Page 523:
19 Information Technology and You D
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People‟s lives have been turned u
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its self-contained rechargeable bat
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Random-Access Memory (RAM) Random-a
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On laptop computers and PDAs, the s
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Operating System An operating syste
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the spreadsheet software together w
Page 539 and 540:
Exhibit 19.5 Pro forma sales and in
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Database Software A database is a c
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Internet e-mail addresses often con
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Personal Finance Software There are
Page 547 and 548:
There are several different approac
Page 549 and 550:
One of the major attractions of the
Page 551 and 552:
While not a new version of the Web
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industrial revolution, and has occu
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Dummies Inc. has a series of books
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organization. This chapter is desig
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As technology has evolved, the term
Page 563 and 564:
While the software mentioned earlie
Page 565 and 566:
Most of the focus of the investor c
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Data Access and OLAP Before the lat
Page 569 and 570:
Exhibit 20.5 illustrates a differen
Page 571 and 572:
Productivity Tools Workers expect t
Page 573 and 574:
Client-server technology is based o
Page 575 and 576:
Today, most programmers write in C+
Page 577 and 578:
Exhibit 20.6 is a model of a typica
Page 579 and 580:
No treatment of relational database
Page 581 and 582:
Online analytical processing (OLAP)
Page 583 and 584:
server) and the rest on the users
Page 585 and 586:
the other operational departments w
Page 587:
The world of business has changed d
Page 591:
Chaffey, Dave, E-Commerce and E-Com
Page 595 and 596:
According to the results of the sur
Page 597 and 598:
understand the financial situation
Page 599 and 600:
MBA graduates who are hoping to ent
Page 601 and 602:
Summary Financial services opportun
Page 603 and 604:
Let‟s begin with the “I left it
Page 605 and 606:
MBA student: “Well, I go to [Grea
Page 607 and 608:
Aiming for Your Goals For career ch
Page 609 and 610:
Networking is generally regarded as
Page 611 and 612:
Let‟s begin with some key assumpt
Page 613 and 614:
like, or moving ahead in the compan
Page 618 and 619:
Accrual accounting: An accounting m
Page 620 and 621:
Cash flow: Cash that is spent or re
Page 622 and 623:
Distribution channel: A chain of in
Page 624 and 625:
Goodwill: As it relates to valuatio
Page 626 and 627:
Management’s discussion and analy
Page 628 and 629:
Ordinary annuity: An annuity that p
Page 630 and 631:
Securities and Exchange Commission
Page 632 and 633:
Vertical merger: A merger in which
Page 634 and 635:
about activity-based costing progre
Page 636 and 637:
Application systems ARPAnet Arthur
Page 638 and 639:
Bell Labs Benefit measurement Beta
Page 640 and 641:
goal orientation legal and contract
Page 642 and 643:
segment information note share-base
Page 644 and 645:
process of purpose of real world us
Page 646 and 647:
uy/build decision capital budget in
Page 648 and 649:
written resume Careers in corporate
Page 650 and 651:
Cell Center for Research in Securit
Page 652 and 653:
Compensation and ownership Competit
Page 654 and 655:
Corporate culture Corporate debt in
Page 656 and 657:
profit planning from an internal pe
Page 658 and 659:
Data Data access and OLAP Database
Page 660 and 661:
Askin Capital Management Barings Ba
Page 662 and 663:
market approach publicly traded gui
Page 664 and 665:
Electronic data interchange (EDI) E
Page 666 and 667:
Extensible markup language (XML) Ex
Page 668 and 669:
short term liquidity users and uses
Page 670 and 671:
Fourth generation programming (4GL)
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Going private Going private transac
Page 674 and 675:
Hypertext links Hypertext markup la
Page 676 and 677:
Information technology and the firm
Page 678 and 679:
International Accounting Standards
Page 680 and 681:
Last-in-first out (LIFO) vs. curren
Page 682 and 683:
Long call option payoff Longer-term
Page 684 and 685:
Market risks Market size and struct
Page 686 and 687:
Motivation to outsource Multiple IR
Page 688 and 689:
Nonrecurring items defined disclosu
Page 690 and 691:
Operational complexity Operational
Page 692 and 693:
Outsourcing metrics Overhead Over-t
Page 694 and 695:
Personal end game Personal expense
Page 696 and 697:
Price competition Price decreases P
Page 698 and 699:
Projected cash flow statements Proj
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Relevant range Relevant range assum
Page 702 and 703:
Risk sharing Risk transfer Risk vs.
Page 704 and 705:
Short call option payoff Short part
Page 706 and 707:
Spot price Spreadsheet software Spr
Page 708 and 709:
Summarizing nonrecurring items and
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acquisition the business dividends
Page 712 and 713:
Timmon‟s Model of Opportunity Rec
Page 714 and 715:
U.S. immigration quotas U.S. Intern
Page 716 and 717:
discounting with discount rate form
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