6-6 Net present Value Terminology C=Cash flow t= time period of the investment r=opportunity cost of capital o The Cash Flow could be positive or negative at any time period Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 6 Irwin/McGraw-Hill Net Present Value Terminology C = Cash Flow t = time period of the investment r = “opportunity cost of capital” The Cash Flow could be positive or negative at any time period
6-7 Net present Value Net Present Value rule Managers increase shareholders' wealth by accepting all projects that are worth more than they cost Therefore, they should accept all projects with a positive net present value Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 7 Irwin/McGraw-Hill Net Present Value Net Present Value Rule Managers increase shareholders’ wealth by accepting all projects that are worth more than they cost. Therefore, they should accept all projects with a positive net present value
6-8 Net present Value Example ou have the opportunity to purchase an office building. You have a tenant lined up that will generate $16,000 per year in cash flows for three years. At the end of three years you anticipate selling the building for $450,000 How much would you be willing to pay for the building? Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 8 Irwin/McGraw-Hill Net Present Value Example You have the opportunity to purchase an office building. You have a tenant lined up that will generate $16,000 per year in cash flows for three years. At the end of three years you anticipate selling the building for $450,000. How much would you be willing to pay for the building?
6-9 Net present Value $466,000 Example- continued $450.000 $16,000 $16,000 $16,000 Present value 0 14. 953 14953 380.395 S409,323 Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 9 Irwin/McGraw-Hill Net Present Value 0 1 2 3 $16,000 $16,000 $16,000 $450,000 $466,000 Present Value 14,953 14,953 380,395 $409,323 Example - continued
6-10 Net present Value Example - continued If the building is being 〓〓 offered for sale at a price of$350,000, would you buy the building and what is the added value generatea by your purchase and management of the building? Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 6- 10 Irwin/McGraw-Hill Net Present Value Example - continued If the building is being offered for sale at a price of $350,000, would you buy the building and what is the added value generated by your purchase and management of the building?