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Versi
: J0434 / Ekonomi Managerial
: 01 September 2005
: revisi
Pertemuan < 26 >
Long-Term Investment Analysis
Chapter 18
Learning Outcomes
Pada akhir pertemuan ini, diharapkan mahasiswa
akan mampu :
membuat analisis keputusan investasi dan
resiko manajemen jangka panjang (C4)
Outline Materi
•
•
•
•
Conflicts Between IRR & NPV
Opportunity Cost of Capital
Optimal Debt-Equity Structure Argument
Constraints on cost-benefit analysis include
Conflicts Between IRR & NPV
Capital Rationing
• Can have multiple IRRs
• For mutually exclusive
If there is a restriction on
projects, IRR can say one
the amount to invest
thing and NPV the other
– List projects by descending
• Can have a tiny project
profitability ratios (PR)
with a Huge IRR
– Select top PR and next,
until amount used up
– If PR < 1, don’t do it, it has
a negative NPV
Therefore, NPV is always
useful. Most financial
economists advocate NPVs
PR =  NCF /( 1 + r) t
t
C0
Opportunity Cost of Capital
• Cost of Debt:
ki = kd ( 1 - t ) after-tax interest
– If kd = 9%, and t = .40 tax rate, ki = 5.4%
• Cost of Equity: ke = rf + risk premium
– If bought own shares ke = D0/P + g div. yield + growth rate
– If using the CAPM
ke = rf + ( km - rf )
• Weighted Average Cost of Capital (WACC)
– ka = wi•ki + we•ke
– there may be some optimal debt-equity structure
Optimal Debt-Equity Structure
Argument
Cost of Debt Financing
is higher than equity
financing, and rises
with percentage debt
Cost of Equity
Financing rises with
percentage debt
ke
ka
ki
optimal
% Debt
Rates of Return: Various Methods
• One period ROR:
r = A1/C0 - 1
Ex: $1,000 investment = C0,
receive A1 =$1,200
20%, or r = 1200/1000 -1
• Multiperiod ROR: IRR
Find r, such that:
 { At / (1 + r ) t = C0
where At are the net cash
flows
• Problem: Find IRR if
the NCF’s are as
follows:
Net Cash Flows
1500
1000
500
0
-500
1
2
3
-1000
-1500
There are several methods
IRR Methods
Find r, such that:
1000/(1+r) + 200/(1+r)2 = 1000
• Trial and Error
or,
– Try 10%, 20%
1000(1+r)+200 = 1000(1+r)2
– as the answer lies
0 = -200 +1000 r + 1000 r 2
between, narrow to 17%
0 = 5•r 2 + 5•r -1
• Financial Calculator
Quadratic Rule:
– Enter the CF’s: -1000;
2 -4(5)(-1)}]/2(5)
r
=
[-5
±
SQRT
{5
1000; 200
r = [-5 ± SQRT{45}]/10
– Push the IRR key
r = -.50 ± .67 or +.17 or 17%
• Analytical: Solve the
equation explicitly
Constraints on cost-benefit analysis include
• Physical constraints. Limited by technology.
• Legal constraints. Laws on property rights.
• Administrative constraints. Hire qualified
administrators.
• Distributional constraints. Must not harm.
• Political constraints. What is possible vs best.
• Financial or budget constraints.
• Social and religious constraints. Cultural and
religious considerations.
Cost Effectiveness Analysis
• In cost-effectiveness analysis we ask what are the costs
of alternative means for reaching goal?
– We know we must fight crime, but what is the
cheapest way to do it?
• Constant-cost studies specify the output for a given
cost from alternative programs.
• Least-cost studies alternative programs to achieve a
given goal are examined in terms of cost.
• Objective-level studies estimate the cost of achieving
several performance levels of the same objective.
Summary
• Therefore, NPV is always useful. Most financial economists
advocate NPVs
• Cost of Debt Financing is higher than equity financing, and
rises with percentage debt
• Cost of Equity Financing rises with percentage debt
• In cost-effectiveness analysis :
- Constant-cost studies specify the output for a given cost from
alternative programs.
- Least-cost studies alternative programs to achieve a given goal are
examined in terms of cost.
- Objective-level studies estimate the cost of achieving several
performance levels of the same objective.