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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
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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
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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%
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Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 4 McGraw Hill/Irwin Department Store Rents
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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
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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?
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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)
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Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 8 McGraw Hill/Irwin Polyzone Production NPV European Company (figures in millions)
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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)
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Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 10 McGraw Hill/Irwin Marvin Enterprises
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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
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Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 12- 12 McGraw Hill/Irwin Marvin Enterprises Value of Garbage Blaster Investment
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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
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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
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