1. Chapter 11 Principles PrinciplesofCorporateFinance Tenth Edition Investment, Strategy, and Economic Rents Slides by Matthew Will Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin

2. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 2 McGraw Hill/Irwin Topics Covered  Look First To Market Values  Economic Rents and Competitive Advantage  Example - Marvin Enterprises

3. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 3 McGraw Hill/Irwin Department Store Rents [assumes price of property appreciates by 3% a year] Rental yield = 10 - 3 = 7%

4. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 4 McGraw Hill/Irwin Department Store Rents

5. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 5 McGraw Hill/Irwin Do Projects Have Positive NPVs?  Rents = profits that more than cover the cost of capital  NPV = PV (rents)  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

6. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 6 McGraw Hill/Irwin Competitive Advantage Proposal to manufacture specialty chemicals  Raw materials were commodity chemicals imported from Europe  Finished product was exported to Europe  High early profits, but... ... what happens when competitors enter?

7. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 7 McGraw Hill/Irwin Polyzone Production NPV U.S. Company (figures in millions)

8. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 8 McGraw Hill/Irwin Polyzone Production NPV European Company (figures in millions)

9. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 9 McGraw Hill/Irwin Polyzone Production NPV U.S. Company w/ European Competition (figures in millions)

10. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 10 McGraw Hill/Irwin Marvin Enterprises

11. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 11 McGraw Hill/Irwin Marvin Enterprises Demand = 80 (10 - Price) Price = 10 x quantity/80 Demand for Garbage Blasters

12. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 12 McGraw Hill/Irwin Marvin Enterprises Value of Garbage Blaster Investment

13. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 13 McGraw Hill/Irwin Marvin Enterprises VALUE OF CURRENT BUSINESS:VALUE At price of $7 PV = 24 x 3.5/.20 420 WINDFALL LOSS: Since price falls to $5 after 5 years, Loss = - 24 x (2 /.20) x (1 / 1.20) 5 - 96 VALUE OF NEW INVESTMENT: Rent gained on new investment = 100 x 1 for 5 years = 299 Rent lost on old investment = - 24 x 1 for 5 years = - 72 227 227 TOTAL VALUE: 551 CURRENT MARKET PRICE: 460

14. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 14 McGraw Hill/Irwin Marvin Enterprises 100 200 280 NPV new plant Change in PV existing plant Total NPV of investment 400 600 200 -200 NPV $m. Addition to capacity millions Alternative Expansion Plans