tailieunhanh - Lecture Fundamentals of financial management - Chapter 12: Other topics in capital budgeting

Lecture Fundamentals of financial management - Chapter 12: Other topics in capital budgeting. This chapter presents the following content: Evaluating projects with unequal lives, identifying embedded options, valuing real options in projects. | CHAPTER 12 Other Topics in Capital Budgeting Evaluating projects with unequal lives Identifying embedded options Valuing real options in projects Evaluating projects with unequal lives Projects S and L are mutually exclusive, and will be repeated. If k = 10%, which is better? Expected Net CFs Year Project S Project L 0 ($100,000) ($100,000) 1 59,000 33,500 2 59,000 33,500 3 - 33,500 4 - 33,500 Solving for NPV, with no repetition Enter CFs into calculator CFLO register for both projects, and enter I/YR = 10%. NPVS = $2,397 NPVL = $6,190 Is Project L better? Need replacement chain analysis. -100,000 59,000 59,000 59,000 59,000 -100,000 -41,000 Replacement chain Use the replacement chain to calculate an extended NPVS to a common life. Since Project S has a 2-year life and L has a 4-year life, the common life is 4 years. 0 1 2 3 10% 4 NPVS = $4,377 (on extended basis) What is real option analysis? Real options exist when managers can influence the size and riskiness of a project’s cash flows by taking different actions during the project’s life. Real option analysis incorporates typical NPV budgeting analysis with an analysis for opportunities resulting from managers’ decisions. What are some examples of real options? Investment timing options Abandonment/shutdown options Growth/expansion options Flexibility options Illustrating an investment timing option If we proceed with Project L, its annual cash flows are $33,500, and its NPV is $6,190. However, if we wait one year, we will find out some additional information regarding output prices and the cash flows from Project L. If we wait, the up-front cost will remain at $100,000 and there is a 50% chance the subsequent CFs will be $43,500 a year, and a 50% chance the subsequent CFs will be $23,500 a year. Investment timing decision tree At k = 10%, the NPV at t = 1 is: $37,889, if CF’s are $43,500 per year, or -$25,508, if CF’s are $23,500 per year, in which case the firm would not proceed with the project. 50% prob. | CHAPTER 12 Other Topics in Capital Budgeting Evaluating projects with unequal lives Identifying embedded options Valuing real options in projects Evaluating projects with unequal lives Projects S and L are mutually exclusive, and will be repeated. If k = 10%, which is better? Expected Net CFs Year Project S Project L 0 ($100,000) ($100,000) 1 59,000 33,500 2 59,000 33,500 3 - 33,500 4 - 33,500 Solving for NPV, with no repetition Enter CFs into calculator CFLO register for both projects, and enter I/YR = 10%. NPVS = $2,397 NPVL = $6,190 Is Project L better? Need replacement chain analysis. -100,000 59,000 59,000 59,000 59,000 -100,000 -41,000 Replacement chain Use the replacement chain to calculate an extended NPVS to a common life. Since Project S has a 2-year life and L has a 4-year life, the common life is 4 years. 0 1 2 3 10% 4 NPVS = $4,377 (on extended basis) What is real option analysis? Real options exist when managers can influence the size and riskiness of a project’s cash