1. Invest and Earn Problem Negative investment cash flow followed by positive return cash flow –Evaluate with IRR or NPV –Traps Infinite cash flow –Truncate it Goes negative later –don’t use IRR –evaluate how you will handle negative flow in real life and then do it to the cash flow »Tweek the IRR by diverting future earnings at the external rate to cover the red ink

2. One More Trick The sunk cost problem –Prior to making an investment most companies spend money to develop or ready the opportunity Example - Oil Industry –Two biggest costs are “finding cost” and “lifting cost”

3. Example Bushy Boys Oil spends $200,000,000 dollars a year for 3 years to find the Dead Seal oil field. The exploration data shows that the oil field contains 100,000,000 barrels of recoverable oil. It will cost $50,000,000 over the next year to bribe lobby officials, run a warm fuzzy PR campaign and get the permits to develop the field. It will then cost $400,000,000 to develop the wells to pump the oil field and to develop the pipeline infrastructure to move the oil.

4. Example Continued It will cost $11/barrel to lift the oil to the surface and another $1.50/barrel to move it to market. If oil will sell for $25/barrel and the oil field will be pumped down evenly over the next 10 years, can the investment yield a 20% rate of return?

5. Cash Flow -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 -200,000,000 -50,000,000 -400,000,000 125,000,000/year Where is the point of decision? What Kind of Problem is this? Invest and Earn Problem

6. Sweeping Into the Pot -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 -200,000,000 -50,000,000 -400,000,000 125,000,000/year -$50,000,000 * 0.833 = -$41,665,000 -$400,000,000 * 0.6944 = -$277,760,000 $125,000,000 * 4.192 =$524,000,000 What Did I Forget to Do? * 0.6944 = $363,865,600 Sum Up = $44,440,600

7. Wrapping Up -3 -2 -1 0 1 2 $44,440,600 NPV What About My $600,000,000 Investment to Find That Oil Field

8. Sunk Costs Can your decision change whether that cost occurs?