Chapter 11 Principles PrinciplesofCorporateFinance Tenth Edition Investment, Strategy, and Economic Rents Slides by Matthew Will Copyright © 2010 by The.

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Presentation transcript:

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

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

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

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

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 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

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 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?

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

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

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

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

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

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

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Marvin Enterprises VALUE OF CURRENT BUSINESS:VALUE At price of $7 PV = 24 x 3.5/ WINDFALL LOSS: Since price falls to $5 after 5 years, Loss = - 24 x (2 /.20) x (1 / 1.20) 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 = TOTAL VALUE: 551 CURRENT MARKET PRICE: 460

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

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