1、,Irwin/McGraw-Hill,Chapter 7,Fundamentals of Corporate Finance Third Edition,Using Discounted Cash Flow Analysis to Make Investment Decisions,Brealey Myers Marcus slides by Matthew Will,Irwin/McGraw-Hill,The McGraw-Hill Companies, Inc.,2001,Topics Covered,Discounted Cash Flows, NetProfits Incrementa
2、l Cash Flows Treatment of Inflation Separation of Investment & Financing Decisions Example: Blooper Industries,Cash Flow vs. Accounting Income,Discount actual cash flows Using accounting income, rather than cash flow, could lead to erroneous decisions.,ExampleA project costs $2,000 and is expected t
3、o last 2 years, producing cash income of $1,500 and $500 respectively. The cost of the project can be depreciated at $1,000 per year. Given a 10% required return, compare the NPV using cash flow to the NPV using accounting income.,Cash Flow vs. Accounting Income,Cash Flow vs. Accounting Income,Incre
4、mental Cash Flows,Discount incremental cash flows Include All Indirect Effects Forget Sunk Costs Include Opportunity Costs Recognize the Investment in Working Capital Beware of Allocated Overhead Costs,Incremental Cash Flows,IMPORTANT Ask yourself this questionWould the cash flow still exist if the
5、project does not exist?,If yes, do not include it in your analysis. If no, include it.,Inflation,INFLATION RULE Be consistent in how you handle inflation! Use nominal interest rates to discount nominal cash flows. Use real interest rates to discount real cash flows. You will get the same results, wh
6、ether you use nominal or real figures,Inflation,ExampleYou own a lease that will cost you $8,000 next year, increasing at 3% a year (the forecasted inflation rate) for 3 additional years (4 years total). If discount rates are 10% what is the present value cost of the lease?,Inflation,Example - nomin
7、al figures,Inflation,Example - real figures,Separation of Investment & Financing Decisions,When valuing a project, ignore how the project is financed. Following the logic from incremental analysis ask yourself the following question: Is the project existence dependent on the financing? If no, you must separate financing and investment decisions.,Blooper Industries,(,000s),Blooper Industries,Cash Flow From Operations (,000s),or $3,950,000,Blooper Industries,Net Cash Flow (entire project) (,000s),NPV 12% = $3,564,000,
