Upload
restu-agusti
View
219
Download
0
Embed Size (px)
Citation preview
7/30/2019 Making Inv Dec
1/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14Strategic Issues In
Making Investments
Decisions
7/30/2019 Making Inv Dec
2/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-2
Investment Decisions
Investments are major decisions that have long-term consequences beyond current consumption.
Two effects of time on a decision and its outcomes
distinguish an investment decision:1. The decision commits resources for a lengthy period of
time, and this commitment usually prevents takinganother future opportunity
2. Managements flexibility to modify an investment as timeand information unfold can affect alternative decisions.
7/30/2019 Making Inv Dec
3/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-3
Learning Objective 1
7/30/2019 Making Inv Dec
4/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-4
Strategic Investments
A strategic investment is a choice amongalternative courses of action and the allocationof resources to those alternatives most likely
to succeed after considering . . .
1) changes in natural, social, and economicconditions, and
2) actions of competitors.
7/30/2019 Making Inv Dec
5/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-5
Learning Objective 2
7/30/2019 Making Inv Dec
6/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-6
Information about External Events
External InformationOrganization's
Financial Records
Interviews withKnowledgeable
IndividualsPublicly Available
informationUncontrollable futureevents
Past financial recordshave limited
usefulness for predicting futureevents if theorganization hasnever operated in asimilar environment
Company personnelwho can think
creatively mightidentify future events.Experiencedconsultants also canbe excellent sourcesof future events.
News, government,foundation, and
industry analyses canbe excellent sourcesof future events
Likelihood of futureevents' occurrence Past financial recordshave limitedusefulness for predicting future oddsif the organizationhas never operated ina similar
environment.
Experiencedconsultants andcompany personnelcan estimate odds ,but individuals arenotoriously weak atthis task.
News, government,foundation, andindustry analyses canbe excellent sourcesof the likeliness of future events.
Sources and Usefulness of External Information
Group brainstorming methods anddecision-support software may helpidentify the range of future events.
7/30/2019 Making Inv Dec
7/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-7
Likelihood of Future Events
Occurrence
Sensitivity Analysis Forecasts the effects of a likely change in each
future, relevant event oninvestment outcomes.
Scenario AnalysisForecasts the effects of likely combinations of
future events oninvestment outcomes.
Expected Value AnalysisSummarizes the combined effects of relevant future
events on decision outcomes, weighted by theprobability or odds of the events occurrence.
7/30/2019 Making Inv Dec
8/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-8
Expected Value Analysis
Relevant Future EventProbability of Occurrence
Annual market growth = 8% 30%
Annual market growth = 4% 40%Annual market growth = 2% 30%Total probability 100%
The management of Matrix, Inc. is in the process of
accessing the probability of market growth for their product. The following consensus has been reached:
ExpectedMarketGrowth
= (8% .30) + (4% .40) + (2% .30)
E[market growth] = 2.4% + 1.6% + .6% = 4.6%
7/30/2019 Making Inv Dec
9/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-9
Internal Information
Internal informationOrganization's
financial records
Interviews withknowledgeable
individualsPublicly available
informationEffect of future eventson investment costs
and benefits
Account or regressionanalysis of financial
records might beuseful to predict costsor benefits if expected futureactivities are similar to recent experience.
Consultants can bringknowledge of other
organizations'experiences withsimilar events.Company personnelcan apply others'experiences andperform engineeringanalysis to predictcosts and benefits.
Descriptions of other organizations'
experiences withsimilar events can behelpful for predictingfuture costs andbenefits.
Sources and Usefulness of Internal Information
7/30/2019 Making Inv Dec
10/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-10
Discounted Cash Flow Analysis
A method of comparing alternativeinvestmentsCombines estimates of present andfuture cash outflows and inflows
associated with each investmentDiscounts the cash flows to accountfor the opportunity costs of committing funds
Differs from payback p er iod methods:DCF Includes all cash flows throughoutthe life of the investmentDCF always discounts the cash flows
7/30/2019 Making Inv Dec
11/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-11
Investment Cash FlowsEstimate separately 3 types of cash flows:1) Investment cash flows
a) Asset acquisition (and disposal of old asset)b) Tax effect from disposal of old assetc) Tax credit arising from the new acquisition
2) Periodic operating cash flowsa) Receipts from operationsb) Cost savings that occur (including tax savings)c) Operating expenses
3) Cash flows from termination of investment
Next, an illustration of these cash flows, courtesy of ShadeTree Roasters.
7/30/2019 Making Inv Dec
12/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-12
Investment Cash FlowsThe entire purchase is made in cash at the end of year
0 (i.e. at start of the investment period)The equipment will be depreciated by the straight-linemethod over 4 years, and there are no salvage valuesOperating income will increase because of higher
sales and savings in energy costsShadeTree Roasters - Investment in New Equipment
Data InputNew equipment cost, includinginstallation and training $200,000Salvage value of new equipment -New equipment useful life 4 yearsSalvage value of old equipment -Annual increase in contrib. margin $30,000Annual energy cost savings $40,000Income tax rate 40%Discount rate 8%
Income tax rate is40% (for effect of depreciation)
Future cash flowsare discounted at8% per year
7/30/2019 Making Inv Dec
13/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-13
Investment Cash FlowsInvestment analysis End of year
Initial cash flows for year: 0 1 2 3 4
Investment cost (200,000)Proceeds from old equipment -
Annual operating income items
Increase in contribution margin 30,000 30,000 30,000 30,000
Energy cost savings 40,000 40,000 40,000 40,000
Depreciation expense (50,000) (50,000) (50,000) (50,000)
Change in operating income 20,000 20,000 20,000 20,000
Tax on change in income (8,000) (8,000) (8,000) (8,000)
After-tax change in operating income 12,000 12,000 12,000 12,000
Add back depreciation expense 50,000 50,000 50,000 50,000
After-tax operating cash flow 62,000 62,000 62,000 62,000
Assume that cash flows are the same in each year. Note that depreciation expense is used only to estimate
the tax savings. The expense itself is not a cash flow. These net cash flows must be discounted to get the
investments net present value.
7/30/2019 Making Inv Dec
14/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-14
Choice of a Discount Rate
The discount rate is an estimate of theopportunity cost of making this investmentinstead of some other.If the rate chosen is too high, some profitableinvestments will be rejected.If the rate chosen is too low, some marginalinvestments will be approved too easily.Suggested discount rates:
A risk-free rate (e.g., Treasury bond rate)Long-term market return on equitiesThe rate chosen should allow for price inflation
%
(1+r)^(-n)
7/30/2019 Making Inv Dec
15/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-15
Cash to be received in the future has a cost.Alternative investments and price inflation
reduce the value of those cash flows incurrent monetary terms (present value).That is why the cash flows are discounted,normally using a constant discount rate.
Assume annual cash flows of $10,000 and a discountrate of 8%. Every dollar received one year from nowhas a present value of ($1)*(1.08 -1)=$0.926. After twoyears a dollar has a present value of $0.857.
Discounting Future Cash Flows$10,000 $10,000 $10,000 $10,000
7/30/2019 Making Inv Dec
16/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-16
Net Present Value
Compute the present value of each cash inflowand outflow.Sum all the present values to get the net
present value (NPV).If the NPV of the investment is greater thanzero, the project promises returns greater thanthe opportunity rate.
The next slide calculates the NPV of theShadeTree Roasters investment proposal.
7/30/2019 Making Inv Dec
17/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-17
Net Present Value
Investment analysis End of year Initial cash flows for year: 0 1 2 3 4
Investment cost (200,000)Proceeds from old equipment -
Annual operating income itemsIncrease in contribution margin 30,000 30,000 30,000 30,000Energy cost savings 40,000 40,000 40,000 40,000Depreciation expense (50,000) (50,000) (50,000) (50,000)
Change in operating income 20,000 20,000 20,000 20,000Tax on change in income (8,000) (8,000) (8,000) (8,000)After-tax change in operating income 12,000 12,000 12,000 12,000Add back depreciation expense 50,000 50,000 50,000 50,000After-tax operating cash flow 62,000 62,000 62,000 62,000
Disposal valuePresent value factors 1.000 0.926 0.857 0.794 0.735Discounted cash flows (200,000) 57,407 53,155 49,218 45,572Net present value 5,352$ Note: =sum(b26:f26)
The proposal estimates an NPV of $5,352. So the present value
of the net cash inflows during four years exceeds the$200,000 initial investment.
So do
we goahead?
I vote Yes!
7/30/2019 Making Inv Dec
18/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-18
Payback PeriodManagers may want to know how soon theywill recover an initial investment.This method counts the time that will passbefore the projected cash inflows equal theinitial cash expenditure.The payback period method complements thediscounted cash flow method, though theresult may be different.In the ShadeTree Roasters example:
Divide the initial investment of $200,000 by theannual contribution margin of $62,000. Thepayback period is 3.23 years.Often the cash flows are not discounted.
7/30/2019 Making Inv Dec
19/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-19
Internal Rate of ReturnThis percentage is calculated together with the investments net present value. An investments IRR is the discount ratethat would create an NPV of zero for theinvestment.So, if the NPV is greater than zero, thenthe IRR will be greater than the discountrate.
In the case of ShadeTree Roasters, theproposed investment would have anIRR of 9.2%, higher than the requiredreturn of 8%.
7/30/2019 Making Inv Dec
20/41Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-20
Learning Objective 3
7/30/2019 Making Inv Dec
21/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-21
Forecasts of Investment InformationThe management of ShadeTree Roasters has gathered the
following information concerning a potential investment.
7/30/2019 Making Inv Dec
22/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-22
Forecasts of Investment InformationForecast and Net Present Value No Major Competitor
$50,000,000 1.046 = $52,300,000
$10,460,000 35% = $3,661,000
7/30/2019 Making Inv Dec
23/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-23
Forecasts of Investment InformationForecast and Net Present Value No Major Competitor
$699,000 40% = $279,600
7/30/2019 Making Inv Dec
24/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-24
Forecasts of Investment InformationForecast and Net Present Value No Major Competitor
=NPV(.08,F15:N15)+D15
7/30/2019 Making Inv Dec
25/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-25
Forecasts of Investment InformationForecast and Net Present Value With Major Competitor
The major competitor does not enter the market until the second year.
7/30/2019 Making Inv Dec
26/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-26
Forecasts of Investment InformationForecast and Net Present Value With Major Competitor
=NPV(.08,F15:N15)+D15
7/30/2019 Making Inv Dec
27/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-27
Expected Value Analysis Decision Tree
NPVCompetitor Outcome E[NPV]
40% (4,965,809)$ (1,986,324)$60% 2,012,498 1,207,499
100% (778,825)$
7/30/2019 Making Inv Dec
28/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-28
Value of Deferring IrreversibleDecisions
Lets assume that ShadeTree Roasters wants toconsider waiting one year to see if its major
competitor decides to enter the market.
All other information remains the same. Letslook at our analysis now.
7/30/2019 Making Inv Dec
29/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-29
Wait One Year, With No MajorCompetitor
7/30/2019 Making Inv Dec
30/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-30
Learning Objective 4
7/30/2019 Making Inv Dec
31/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-31
Wait One Year, With a MajorCompetitor
7/30/2019 Making Inv Dec
32/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-32
Defer Decision One Year
First Second NPV Bestdecision Probability Competitor? decision outcome choice
Expand (4,139,865)$ No40% Yes
Don't expand -$ YesDon't decide
Expand 2,618,754$ Yes60% No
Don't expand -$ No
E[NPV] = $ 1,571,252
($0 .40) + ($2,618,754 .60) = $1,571,252
7/30/2019 Making Inv Dec
33/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-33
Value of the Option to Wait
Under common investment conditions, the netpresent value that we calculated in our analysisis incorrect . We did not consider the situation
where ShadeTree entered the market but
terminated the project after one year when amajor competitor may enter the same market.Though ShadeTree would not recover its
investment (which is a sunk cost), it may beless costly to terminate after one year than to
continue operations in the market. This analysisis referred to as real option value.
7/30/2019 Making Inv Dec
34/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-34
Learning Objective 5
7/30/2019 Making Inv Dec
35/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-35
Real Option Value Decision TreeSecond NPV Best
Decision now Choice Prob Competitor? decision outcome choice
Continue (5,662,762)$ No40% Yes
Terminate (4,093,148)$ YesExpand
Continue 2,925,012$ YesExpand now or not 60% No
Terminate (4,093,148)$ NoDon't expand -$
E[NPV, expand now] = [$(4,093,138) .40] + [$2,925,012 .60]
E[NPV, expand now] = $117,752
7/30/2019 Making Inv Dec
36/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-36
Value of the Option to WaitIf ShadeTree postpones its
decision to expand for one year and then expands into the new
market, we calculate theexpected net present value to be:
$1,571,252 If ShadeTree expands now and
continues operations, wecalculate the expected net
present value to be:$117,752
Postpone one year 1,571,252$Expand now 117,752
Expected value of waiting 1,453,500$
14 37
7/30/2019 Making Inv Dec
37/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-37
Learning Objective 6
14 38
7/30/2019 Making Inv Dec
38/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-38
Legal and Ethical Issues in StrategicInvestment Analysis
Trade unions, regulators, investors, non-governmentorganizations and some business executives have
succeeded in influencing United States laws and recentOrganisation for Economic Cooperation and
Development guidelines that prohibit bribery and other corrupt practices by multination companies.
Such acts are designed todiscourage companies from illegally
obtaining information about theintentions of competitors.
14 39
7/30/2019 Making Inv Dec
39/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-39
Internal Ethical Pressures
1. Bias from personal commitment to aninvestment project.
2. Fear of loss of prestige, position, or compensation from a failed investment.
3. Greed and intentional behavior todefraud an organization or itsstakeholders.
14 40
7/30/2019 Making Inv Dec
40/41
Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved . McGraw-Hill/Irwin
14-40
Role of Internal Controls and Audits
o Hiring practices -- performing background andreference checks.
o Investment reporting and reviews -- periodicprogress reporting to see if the investment is
meeting stated goals.o Codes of ethics -- educate and support employees
who want to behave ethically.
o Internal audits -- examinations of operations,programs, and financial results performed byindependent investigators.
14-41
7/30/2019 Making Inv Dec
41/41
14-41
End of Chapter 14