1、CHAPTER 4 INVESTMENT DESISION,Section 1 Fixed assets investment decision-making,1. Procedure of fixed assets investment decision-making： （1）Estimate expected cash flow of the investment program. （2）Estimate the risk of expected cash flow and determine the average level of capital cost. （3）Determine
2、the present value of investment programs income. （4）Decide to accept or refuse the investment program by comparing the present value of income and the capital expenditure.,2. Cash flow of the investment program (1) Cash outflow Cash outflow of a program refers to the increase in the amount of cash o
3、utflow caused by the program. (2) Cash inflow Cash inflow of a program refers to the increase in the amount of cash inflow caused by the program. (3) Net cash flow It refers to the deference between the amount of cash inflow and the amount of cash outflow in a certain period., When estimating the am
4、ount of cash flow, we should pay attention to two questions: (1) Distinguish relevant cost and irrelevant cost Relevant cost refers to the cost that is relevant to the certain decision and must be considered in the analysis of the projects. Irrelevant cost refers to the cost that is irrelevant to th
5、e certain decision and neednt be considered in the analysis. (2) Dont neglect opportunity cost,3. The general approach of investment decision (1) Net present value method NPV refers to the difference between the present value of futures cash inflow and cash outflow.,Example：Suppose the discount rate
6、 is10，there are three investment opportunities, therere three investment opportunities, the relevant data is as follows： Please answer：which project should be selected?,(2) Internal rate-of-return(IRR) method IRR refers to the account rate that make the present value of futures cash inflow equal to
7、the that of futures cash outflow. When calculating IRR, we often adopt “step-by-step test”.,4. The decision of renewal of fixed assets Example：A hotel has a old equipment, engineers put in a replacement claim，the relevant data is as follows:,suppose the lowest rate of return which is requested by th
8、e hotel is 15，please answer：should the hotel go on using the old equipment or purchase the new equipment?,5. The influence of income tax and depreciation on investment decisions (1) after-tax cost and after-tax income example：A hotels statement of income is as follows, the hotel is considering an ad
9、vertising plan of paying 2000 dollar monthly, income tax rate is 40. Please answer：Whats the after-tax cost of the advertisement？,conclusion costs after tax = costs before tax*(1- income tax) revenue after tax = revenue before tax*(1- income tax),(2) Tax shield of depreciation Depreciation can reduc
10、e taxable income, its known as “tax shield”. example：Suppose annual sales and cash expenses of hotel A and hotel B are equal, the income tax rate is 40. The only difference between them is hotel A has a fixed asset. The cash flow of the two hotels is as follows：,Depreciations affect on tax,Depreciat
11、ions affect on tax,(3) Calculation of business cash flow after tax business cash flow after taxrevenuecash costincome tax business cash flow after taxnet profit + depreciation business cash flow after taxrevenue（1tax rate）cash cost（1tax rate）+depreciation*tax rate Example 5：Hotel A has a equipment w
12、hich was bought 3 years ago. Now the management is considering whether to replace it. The income tax rate is 40，and the other data is as below. Please decide：should the hotel go on using the old equipment or replace it?,6. Investment risks analysis (1) Risk-adjusted discount rate(RADR) The basic ide
13、a：using higher discount rate to calculate the NPV of the high risk project, then select the best project according to the rules of NPV method.,Example 6：the lowest rate of return of firm A is 6,，there are three investment opportunities，the data is as follows：,(2) Surely-balanced method The basic ide
14、a：adjusting the risk cash flow to risk-free cash flow, then using risk-free discount rate to calculate NPV.,Section 2 Portfolio Investment,1. Bond investment major types： According to the issuer，bonds can be divided into government bond, financial bond and corporate bond. According to the maturity,
15、bonds can be divided into short-term bond, medium-term bond and long-term bond. According to the rate of interest, bonds can be divided into fixed rate bond and floating rate bond., registered bond and non-registered bond listed bond and unlisted bond Evaluation of returns on bond investment (1) bon
16、d value It refers to the present value of the bonds future cash inflow. Example 1：Company ABC is going to buy a bond of $1000 on Dec. 1st , 2010, the nominal interest rate is 8%, the interest will be calculated and paid on Dec. 1st annually, and the maturity is Nov. 30th, 2015. Now the market rate o
17、f interest is 10%, the market price of the bond is $920. Please decide：Should the company buy the bond?,(2) Yield to maturity It refers to the yield rate of holding the bond to its maturity. Its the discount rate that can make the present value of cash inflow equal to the call price of the bond. Exa
18、mple 2： Company ABC bought a bond of $1000 at price of $1105 on Dec. 1st , 2004, the nominal interest rate was 8%, the interests were calculated and paid on Dec. 1st annually, and the maturity was Nov. 30th, 2009. The company holded the bond to its maturity. Please calculate the yield to maturity.,E
19、xample 3：Company ABC bought a bond of $1000 at par on Dec. 1st , 2004, the nominal interest rate was 8%, the interest was calculated just on the principal, the maturity was Nov. 30th, 2009, and all the principal and interest were repaid on that day. If the company hold the bond to maturity, please c
20、alculate the yield to maturity. (3) Interest rate exposure Example 4：Company ABC bought 3-year treasury bills of $1 million on par in 2008, the nominal interest rate was 14. If the market rate of interest rose to 24 one year later，please answer: how much lower was the value of the treasury bills ？,2
21、. Investment in stocks （1）Calculation of shares value fundamental mode of evaluation value of zero growth stock value of fixed growth stock value of non-fixed growth stock,Example 5：A investor owns shares of company ABC, the lowest rate of return he requires is 15. The dividend of the company is exp
22、ected to keep a rapid growth of 20. After that, the dividend will keep a normal growth of 12. The latest dividend was $2. Please calculate the value of the companys share.,3. Risk analysis of portfolio investment（1）PER深沪A股市盈率最大10名（2010.5.11）,（2）Quantitative analysis of portfolio (1) Dispersion risk
23、theory According to the dispersion risk theory, return of the portfolio is the weighted mean of each stocks return in the portfolio, but risk of the portfolio is not the weighted mean of each stocks risk in the portfolio. So portfolio can reduce risk.,Example 6：Suppose you invest $1 million to buy s
24、tock A and B, each of them accounts for 50. Figure 1：perfect negative correlation between A and B,Figure 2 Perfect positive correlation between A and B,(2) Analysis on Beta coefficient Beta coefficient reflects the change degree of individual stock with respect to average risk stock. Beta coefficien
25、t measurers market risk of individual stock, not company specific risk. Example 7：Somebody invested $1 million to buy three shares. He invested $0.3 million in share A, $0.3 million in share B and $0.4 million in share C. Their Beta coefficient is 1.5. Suppose the investor sold share A and bought sh
26、are D, the Beta coefficient of the latter is 0.1. The expected rate of return of the share A, B, C and D is 18,15,20 and 13。Please answer: If change C for D, what will happening to the portfolios risk and expected rate of return?,(3) Capital asset pricing model (CAPM) Example 8：The rate of return of treasury bill is 12%, the required rate of return of average risk share is 16%, the Beta coefficient of share A is 1.5 and its a fixed growth stock with growth rate of 5%，the expected dividend of one year later is $2. Please calculate the value of this share.,
