# Where positive net present values come from The computer has no commercial future – IBM 1948.

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Where positive net present values come from The computer has no commercial future – IBM 1948

Smart investments are worth more than they cost: they have positive NPVs Firms calculate project NPVs by discounting forecast cash flows, but...

Projects may appear to have positive NPVs because of forecasting errors e.g. some acquisitions result from errors in a DCF analysis

Positive NPVs stem from a comparative advantage Strategic decision-making identifies this comparative advantage; it does not identify growth areas

How to decide whether projects have positive NPVs Economic Rents = profits that more than cover the cost of capital NPV = PV (rents) Economic Rents come only when you have a better product, lower costs or some other competitive edge Sooner or later competition is likely to eliminate rents

Dont make investment decisions on the basis of errors in your DCF analysis. Start with the market price of the asset and ask whether it is worth more to you than to others.

Dont assume that other firms will watch passively. Ask -- How long a lead do I have over my rivals? What will happen to prices when that lead disappears In the meantime how will rivals react to my move? Will they cut prices or imitate my product?

Where is NPV coming from? Example #1 Valuing a new department store NPV = -100 + +... + = \$ 819,337.60 [assumes price of property appreciates by 3% a year] * If property does not appreciate, NPV is negative \$12.28 million. 8 8 + 134 1.10 1.10 10

Where is NPV coming from? Example #2 Value of Marvins investment NPV new plant = 100 x [-10 + ((6 - 3)/1.2 t ) + (2/.2)(1/(1.2 5 )] = \$299 million Change PV existing plant = 24 x (1/1.2 t ) = \$72 million Net benefit = 299 - 72 = \$227 million t = 1 5 5

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