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    Mmi 05 Bma 11 Inv Strategy and Ec Rents

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    chooisin
    corporate finance chap 11

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    Mmi 05 Bma 11 Inv Strategy and Ec Rents

    Uploaded by

    chooisin
    109 views19 pages
    corporate finance chap 11

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    corporate finance chap 11

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    109 views19 pages

    Mmi 05 Bma 11 Inv Strategy and Ec Rents

    Uploaded by

    chooisin
    corporate finance chap 11

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    You are on page 1of 19

    Chapter 11

    INVESTMENT, STRATEGY,
    AND ECONOMIC RENTS

    Brealey, Myers, and Allen


    Principles of Corporate Finance
    11th Global Edition
    McGraw-Hill Education Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
    11-1 LOOK FIRST TO MARKET VALUES

    Smart investment decisions make more


    money than smart financing decisions
    Smart investments are worth more than
    they cost, i.e. positive NPVs
    Firms calculate NPVs by discounting
    forecast cash flows
    But, we know these already!

    11-2
    11-1 LOOK FIRST TO MARKET VALUES
    Managers must know the source of positive
    NPVs
    Projects may show positive NPVs due to
    forecasting errors or WACC estimation errors
    Generally, positive NPVs should come from a
    comparative advantage of the firm
    Start with the market price of the asset and ask
    whether it is worth more to you than to others
    Strategy analysis identifies this comparative
    advantage
    11-3
    11-1 LOOK FIRST TO MARKET VALUES

    Dont assume other firms will watch


    passively. Do not underestimate
    competition, even from small firms
    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?
    11-4
    11-1 LOOK FIRST TO MARKET VALUES
    Department Store Rents (pages 274-275)
    Building cost $100, CF $8 per year for 10 yrs, real estate
    prices increase 3% per year. NPV is as follows:

    8 8 8 134
    NPV 100 2
    ...
    1.10 1.10 1.1010
    $1,000,000
    What can go wrong?
    Building prices
    Stores revenue

    Market rental of similar building


    11-5
    FIGURE 11.1 DEPARTMENT STORE RENTS

    11-6
    11-1 LOOK FIRST TO MARKET VALUES

    Example: King Solomons mine

    Investment = $400 million


    Life = 10 years
    Production = .1 million oz. a year
    Production cost = $480 per oz.
    Current gold price = $800 per oz.
    Discount rate = 10%

    11-7
    11-1 LOOK FIRST TO MARKET VALUES

    Example, continued
    If the gold price is forecasted to rise by 5% p.a.:
    .10(840 480) .10(882 480)
    NPV 400 2
    ..... $70 million
    1.10 1.10
    But if gold is fairly priced, you do not need to
    forecast future gold prices because current price =
    pv of future price.

    NPV = investment + PV revenues PV costs

    .1 480 10
    400 800 t
    $105 million
    t 1 1.10

    11-8
    11-1 LOOK FIRST TO MARKET VALUES

    Does Project Have Positive NPVs?


    Economic 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

    11-9
    11-1 LOOK FIRST TO MARKET VALUES

    Competitive Advantage:
    Proposal to manufacture specialty chemicals in
    US, but raw materials were imported from
    Europe. Finished product was exported to
    Europe.
    Due to new technology, company gets high profits in
    early years, but what happens when competitors
    enter?

    What happens when European companies start


    producing the product?

    11-10
    TABLE 11.1 NPV CALCULATION, U.S. COMPANY

    11-11
    TABLE 11.2 NPV CALCULATION, EUROPEAN
    COMPANY

    11-12
    TABLE 11.3 NPV CALCULATION, U.S. COMPANY
    WITH EUROPEAN COMPETITION

    11-13
    HOMEWORK: SELF STUDY
    MARVIN ENTERPRISES, Pages 281-288
    (old book), pages 288-294 (new book)

    11-14
    TABLE 11.4 GARGLE BLASTER INDUSTRY

    11-15
    FIGURE 11.2 DEMAND FOR GARGLE BLASTERS

    11-16
    11-3 MARVIN ENTERPRISES DECIDES TO EXPLOIT
    A NEW TECHNOLOGYAN EXAMPLE
    Value of Gargle Blaster Investment

    6 3 10
    NPV new plant 100 10 t

    1.2 1.25
    $299 million
    1
    Change PV existing plant 24 t
    $72 million
    1.2
    Net benefit 299 72 $227 million

    11-17
    11-3 MARVIN ENTERPRISES DECIDES TO EXPLOIT
    A NEW TECHNOLOGYAN EXAMPLE
    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

    TOTAL VALUE: 551

    CURRENT MARKET PRICE: 460


    11-18
    FIGURE 11.3 ALTERNATIVE EXPANSION PLANS

    11-19

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