Chapter 5 -- Measuring Investment
Value: You Can Trust NPV
 Goals
for this chapter:
 Be
able to calculate the NPV for projects with:
Year-end cash flows
Midyear cash flows
Mixed year-end and midyear cash flows
Understand
the meaning of NPV
Understand management role in
conveying information to the market
NPV of Year End Cash Flows
 Calculate
the net present value of a project with year
end cash flows.
Problems 5-1 -- Even cash flows
Problems 5-4 -- Declining cash flows
Problems 5-5 -- Uneven cash flows
Problems 5-7 -- Overhaul cost and even cash flows
Problems 5-16 -- Growing cash flows
On all of these problems you can use the NPV
function to calculate the present value
Overview of the Calculation of NPV
 On
all NPV problems you must
 First

estimate and then calculate the cash flows for each year
Remember inflows are positive and outflows are negative
 There
are three stages of a projects life
The acquisition stage
 The operating stage
 The disposition stage

 Once
the cash flows for each period are estimated they need
to be discounted to present by multiplying by 1 / (1 + i )n
What Creates a Positive
Net Present Value?
 How
do the following interact to create a
positive net present value?
Market Imperfections
Strategy
Competitive Advantage
Economic profit
Meaning of Net Present Value
 NPV
measures wealth created regardless of
whether or not the company includes debt in its
capital structure.
Tables 5-2 and 5-3
 NPV measures wealth created even in the
presence of income taxes.
Table 5-4
 The presence of risk changes a NPV to an
expected NPV with ranges
Management’s Role in Helping the
Market Assess the NPV of the Firm
 Management
must practice due diligence in
estimating the cash flows and NPVs and then
keep the shareholders informed so that the
market price will equal the intrinsic value over
time.
 If they do not, difficulties begin when investors
are not fully informed and the market price is
substantially different from the intrinsic value.