1. Copyright  1998 by Harcourt Brace &Company Chapter 3 Valuation Order Order Sale Cash Placed Received Received Accounts Collection Accounts Collection Time ==> Time ==> Accounts Disbursement Accounts Disbursement Invoice Payment Cash Invoice Payment Cash Received Sent Paid Received Sent Paid Order Order Sale Cash Placed Received Received Accounts Collection Accounts Collection Time ==> Time ==> Accounts Disbursement Accounts Disbursement Invoice Payment Cash Invoice Payment Cash Received Sent Paid Received Sent Paid

2. Copyright  1998 by Harcourt Brace &Company Objectives v Use cash flow timeline and discounting technique to value future cash flows v Explain importance for using time value of money in short-term decisions v Apply the NPV technique to select value-enhancing projects v Recognize difficulties in selecting appropriate discount rate

3. Copyright  1998 by Harcourt Brace &Company Two Financial Decision- Making Approaches v Financial statement approach v Valuation approach

4. Copyright  1998 by Harcourt Brace &Company Financial Statement Approach v Approach –compute incremental revenue and expense effects of proposal –calculate anticipated profit effect v Calculation steps –estimate unit sales and multiply by profit margin –estimate capital costs of additional required investments such as receivables, inventory, etc. –estimate additional bad-debt loss if new credit terms –calculate overall profit effect v Decision criteria –if anticipated profit is >=0, proposal would contribute profit –if anticipated profit is <0, proposal would not contribute profit

5. Copyright  1998 by Harcourt Brace &Company Valuation Approach v Approach –accounts for timing of cash flows –accounts for present values –results in making value enhancing decisions v Four steps –determine relevant cash flows –determine timing of cash flows –determine appropriate discount rate –discount cash flows v Decision criteria –if NPV >= 0 invest –if NPV < 0 do not invest

6. Copyright  1998 by Harcourt Brace &Company NPV Calculations v Simple interest – 1 PV = FV x ------------------- k (1 + (------) x n) 365 v Compound interest – 1 PV = FV x -------------- k (1+ -------) n 365

7. Copyright  1998 by Harcourt Brace &Company Basic Valuation Model........ note: i = k/365 CF o CF 1 CF 2 CF 3 CF n CF 1 CF 2 CF 3 CF n NPV = CF o + ------------- + ------------- + ------------ +.... + ------------ (1 + i x 1) (1 + i x 2) (1 + i x3) (1 + i x n)

8. Copyright  1998 by Harcourt Brace &Company Valuation Using NPV v Solving Marvel’s financial dilemma

9. Copyright  1998 by Harcourt Brace &Company Choosing the Discount Rate v Three unique problems –funds are rarely raised specifically to fund short-term type projects –short-time horizon implies short-term not long-term rate –risk should be accounted for, but may be ambiguous. v One-shot projects –if net borrower, use short-term borrowing rate –if net investor, use short-term investment rate v Multi-year projects –may be appropriate to use cost of capital  Formulation: k adj = k rf + k avg + k 

10. Copyright  1998 by Harcourt Brace &Company Summary v Short-term financial decisions can impact firm value by: –altering operating cash flows –changing the length of the cash conversion cycle –changing company risk posture –impacting net interest income –and by changing accuracy and timeliness of critical information. v Both financial statement approach and valuation offer insight in working-capital management decisions. v Choosing appropriate discount rate is an issue when trying to assess valuation impact.