The Net Present Value Profile
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Real Options: Dos and Don’Ts Real Options in the Pharmaceutical In- Abandons Projects That Are Not Profit- Dustry Became Popular in the Late Nine- Able
Real Options: Dos and Don’ts Real options in the pharmaceutical in- abandons projects that are not profit- dustry became popular in the late nine- able. According to DiMasi2 33% of ties and in the beginning of the new abandonment of clinical projects is due century. At Merck real options have to economic reasons. This means that been in use at least since 1995. “…, within pharmaceutical companies prof- enthusiasts of real options analysis pre- itability or value of a project is an impor- dict their approach will become the pre- tant criterion when deciding on continu- ferred method of investment valuation ing or abandoning a project. In real op- in 10 years.”1 Today most large pharma- tions valuation we therefore consider ceutical companies have a real options various scenarios where some parame- specialist in their valuation teams. But ters, typically the sales expectation, fluc- after about 15 years we can say today tuate. This means that we assume al- that primarily students and professors ready beforehand that at a later point in are enthusiastic about real options time the opinion about the potential of valuation; people that have not seen the a product might change. These changes daily business within the industry. Real can be for the better or for the worse. In options will never replace the good old case of a sufficiently large deterioration risk-adjusted net present value method. management will stop the projects to There are three reasons for our claim: prevent further losses. 1. Real options are still too complex for upper management. 2. -
The Promise and Peril of Real Options
1 The Promise and Peril of Real Options Aswath Damodaran Stern School of Business 44 West Fourth Street New York, NY 10012 [email protected] 2 Abstract In recent years, practitioners and academics have made the argument that traditional discounted cash flow models do a poor job of capturing the value of the options embedded in many corporate actions. They have noted that these options need to be not only considered explicitly and valued, but also that the value of these options can be substantial. In fact, many investments and acquisitions that would not be justifiable otherwise will be value enhancing, if the options embedded in them are considered. In this paper, we examine the merits of this argument. While it is certainly true that there are options embedded in many actions, we consider the conditions that have to be met for these options to have value. We also develop a series of applied examples, where we attempt to value these options and consider the effect on investment, financing and valuation decisions. 3 In finance, the discounted cash flow model operates as the basic framework for most analysis. In investment analysis, for instance, the conventional view is that the net present value of a project is the measure of the value that it will add to the firm taking it. Thus, investing in a positive (negative) net present value project will increase (decrease) value. In capital structure decisions, a financing mix that minimizes the cost of capital, without impairing operating cash flows, increases firm value and is therefore viewed as the optimal mix. -
How Risky Is the Debt in Highly Leveraged Transactions?*
Journal of Financial Economics 27 (1990) 215-24.5. North-Holland How risky is the debt in highly leveraged transactions?* Steven N. Kaplan University of Chicago, Chicago, IL 60637, USA Jeremy C. Stein Massachusetts Institute of Technology Cambridge, MA 02139, USA Received December 1989, final version received June 1990 This paper estimates the systematic risk of the debt in public leveraged recapitalizations. We calculate this risk as a function of the difference in systematic equity risk before and after the recapitalization. The increase in equity risk is surprisingly small after a recapitalization, ranging from 37% to 57%, depending on the estimation method. If total company risk is unchanged, the implied systematic risk of the post-recapitalization debt in twelve transactions averages 0.65. Alternatively, if the entire market-adjusted premium in the leveraged recapitalization represents a reduction in fixed costs, the implied systematic risk of this debt averages 0.40. 1. Introduction Highly leveraged transactions such as leveraged buyouts (LBOs) and lever- aged recapitalizations have grown explosively in number and size over the last several years. These transactions are largely financed with a combination of senior bank debt and subordinated lower-grade or ‘junk’ debt. Recently, the debt in these transactions has come under increasing scrutiny from investors, politicians, and academics. All three groups have asked in one way or another how risky leveraged buyout debt is in relation to the return it *Cedric Antosiewicz provided excellent research assistance. Paul Asquith, Douglas Diamond, Eugene Fama, Wayne Person, William Fruhan (the referee), Kenneth French, Robert Korajczyk, Richard Leftwich, Jeffrey Mackie-Mason, Merton Miller, Stewart Myers, Krishna Palepu, Richard Ruback (the editor), Andrei Shleifer, Robert Vishny, and seminar participants at the Securities and Exchange Commission, the University of Chicago, and MIT’s Sloan School made helpful comments on earlier drafts. -
The Study of Evaluative Models on Drug Development Status In
EVALUATIONS OF DRUG DEVELOPMENT STATUS IN BIOPHARMACEUTICAL INDUSTRY Tsuei-Ling Liu, Department of Business Administration, Chang Gung University, 259 Wen-Hwa 1st Rd., Kwei-Shan, Tao-Yuan, Taiwan, Tel: 886-3-2118800, Email: [email protected] Shiow-Ying Wen, Department of Business Administration, Chang Gung University, 259 Wen-Hwa 1st Rd., Kwei-Shan, Tao-Yuan, Taiwan, Tel: 886-3-2118800, Email: [email protected] Abstract: This study aims to investigate the evaluation methods of drug development status in biopharmaceutical industry by comparing the traditional NPV analysis, the risk-adjusted NPV (rNPV) method, and the real option evaluation approach. Theoretical models and simulations are represented and discussed in the paper. The paper also gives an empirical case study. We demonstrate that the risk-adjusted approach and the strict option-based method have better performance in the valuation of the biopharmaceutical R&D projects. The empirical results of our study may provide empirical evidence of the reliable valuation models. INTRODUCTION Valuation of biopharmaceutical R&D project is quite difficult to managers and investors in making the investment decision because of the great technological and market uncertainties in this industry. It believes that the traditional NPV analysis is not the appropriate tool to evaluate an early-stage R&D project as it ignores the managerial flexibility in the stage of an investment. Therefore, the major aim of our study is to investigate the better method for R&D evaluation in which can be applied to investment decisions, collaboration or M&A in biotechnology companies, by comparing the traditional NPV analysis, the risk-adjusted NPV (rNPV) method, and the real option evaluation method. -
Net Present Value (NPV): the Basics & the Pitfalls
Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com Net Present Value (NPV): The Basics & The Pitfalls Cobec Consulting Kevin Schutt, Manager Nathan Honsowetz, Consultant ICEAA Conference, June 2013 Agenda Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 2 Time Value of Money Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com Discount Factor “A nearby penny is worth a distant dollar” ‐ Anonymous 3 Time Value of Money Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com Year 1 2 3 4 FV1 FV2 FV3 FV4 PV1 PV2 PV3 PV4 4 Inputs to NPV Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 5 NPV Example Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 6 Investment Alternatives Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com If NPV > 0 No correlation IRR > Cost of Capital Benefit/Cost > 1 7 Economic Analysis Regulations Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 8 NPV in the Private Sector Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com 9 Net Present Value: The Pitfalls Presented at the 2013 ICEAA Professional Development & Training Workshop - www.iceaaonline.com Pitfall! Activision, 1982 10 NPV Pitfall #1: Formula error Presented at the 2013 ICEAA -
Financial Market Analysis (Fmax) Module 2
Financial Market Analysis (FMAx) Module 2 Bond Pricing This training material is the property of the International Monetary Fund (IMF) and is intended for use in IMF Institute for Capacity Development (ICD) courses. Any reuse requires the permission of the ICD. The Relevance to You You might be… § An investor. § With an institution that is an investor. You may be managing a portfolio of foreign assets in a sovereign wealth fund or in a central bank. § With an institution that is in charge of issuing sovereign bonds. § With an institution that is a financial regulator. Defining a Bond – 1 A bond is a type of fixed income security. Its promise is to deliver known future cash flows. § Investor (bondholder) lends money (principal amount) to issuer for a defined period of time, at a variable or fixed interest rate § In return, bondholder is promised § Periodic coupon payments (most of the times paid semiannually); and/or § The bond’s principal (maturity value/par value/face value) at maturity. Defining a Bond – 2 Some bond have embedded options. § Callable Bond: The issuer can repurchase bond at a specific price before maturity. § Putable Bond: Bondholder can sell the issue back to the issuer at par value on designated dates (bond with a put option). Bondholder can change the maturity of the bond. Central Concept: Present Value The Present Value is… § The value calculated today of a series of expected cash flows discounted at a given interest rate. § Always less than or equal to the future value, because money has interest- earning potential: time value of money. -
Study Guide Corporate Finance
Study Guide Corporate Finance By A. J. Cataldo II, Ph.D., CPA, CMA About the Author A. J. Cataldo is currently a professor of accounting at West Chester University, in West Chester, Pennsylvania. He holds a bachelor degree in accounting/finance and a master of accounting degree from the University of Arizona. He earned a doctorate from the Virginia Polytechnic Institute and State University. He is a certified public accountant and a certified management accountant. He has worked in public accounting and as a government auditor and controller, and he has provided expert testimony in business litigation engage- ments. His publications include three Elsevier Science monographs, and his articles have appeared in Journal of Accountancy, National Tax Journal, Research in Accounting Regulation, Journal of Forensic Accounting, Accounting Historians Journal, and several others. He has also published in and served on editorial review boards for Institute of Management Accounting association journals, including Management Accounting, Strategic Finance, and Management Accounting Quarterly, since January 1990. All terms mentioned in this text that are known to be trademarks or service marks have been appropriately capitalized. Use of a term in this text should not be regarded as affecting the validity of any trademark or service mark. Copyright © 2015 by Penn Foster, Inc. All rights reserved. No part of the material protected by this copyright may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without permission in writing from the copyright owner. Requests for permission to make copies of any part of the work should be mailed to Copyright Permissions, Penn Foster, 925 Oak Street, Scranton, Pennsylvania 18515. -
Net Present Value (NPV) Analysis
PROGRAMME LIFECYCLE STRATEGIC PHASE DELIVERY PHASE INITIATION DEFINITION ESTABLISHMENT MANAGEMENT DELIVERY STAGE CLOSE STAGE STAGE STAGE STAGE PROGRAMME PROGRAMME PROGRAMME PROGRAMME FEASIBILITY DESIGN IMPLEMENTATION CLOSEOUT STAGE OBJECTIVES SCOPING PRIORITISATION OPTIMISATION NPV 1 NPV 2 Programme Prioritisation Net Present Value (NPV) analysis Helping our clients prioritise programmes and projects. By the Introduction of a Financial prioritisation model using NPV analysis What is NPV analysis? Where Does NPV analysis Fit into the Overall Programme Cycle? Net Present Value (NPV) is an effective front end management tool for a programme of works. It’s primary role The 1st NPV process is positioned at the front end of a capital is to confirm the Financial viability of an investment over a programme (NPV1 below). It allows for all projects within a long time period, by looking at net Discounted cash inflows programme to be ranked on their Net Present Values. Many and Discounted cash outflows that a project will generate organisations choose to use Financial ratio’s to help prioritise over its lifecycle and converting these into a single Net initiatives and investments. Present Value. (pvi present value index) for comparison. The 2nd NPV process takes place at the Feasibility stage of A positive NPV (profit) indicates that the Income generated a project where a decision has to be made over two or more by the investment exceeds the costs of the project. potential solutions to a requirement (NPV 2 below). For each option the NPV should be calculated and then used in the A negative NPV (loss) indicates that the whole life costs of evaluation of the solution decision. -
FINANCIAL ANALYSIS a Controller’S Guide Second Edition
ffirs.qxd 10/16/06 4:13 PM Page iii FINANCIAL ANALYSIS A Controller’s Guide Second Edition Steven M. Bragg John Wiley & Sons, Inc. ffirs.qxd 10/16/06 4:13 PM Page ii ffirs.qxd 10/16/06 4:13 PM Page i FINANCIAL ANALYSIS Second Edition ffirs.qxd 10/16/06 4:13 PM Page ii ffirs.qxd 10/16/06 4:13 PM Page iii FINANCIAL ANALYSIS A Controller’s Guide Second Edition Steven M. Bragg John Wiley & Sons, Inc. ffirs.qxd 10/16/06 4:13 PM Page iv This book is printed on acid-free paper. ࠗ∞ Copyright © 2007 by John Wiley & Sons, Inc. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmit- ted in any form or by any means, electronic, mechanical, photocopying, recording, scan- ning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com. Requests to the Publisher for per- mission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically dis- claim any implied warranties of merchantability or fitness for a particular purpose. -
Present Value (Fixed Interest Rate): the Arb Fixed-Income Securities Lecture 2
Various interest rates Fixed-income Securities We will start with the nuts and bolts of fixed-income securities by having a look at Lecture 2: Basic Terminology and Concepts the definitions and inter-relations of various interest rates. Talking about interest Philip H. Dybvig rates instead of prices is important for intuition, communication, and calculation. Washington University in Saint Louis For example, quoting a bond yield is much more comparable across maturities, size, and coupon rate than quoting a price. In this lecture, we will focus on a clear • Various interest rates description of the concepts, leaving some institutional details to next lecture. • Present value (PV) and arbitrage During this lecture, we consider looking at trades made at one date for claims to nonrandom cash flows at future dates. Although no explicit mention of uncer- • Forward and spot interest rates tainty will be made, we will learn later that beliefs about future random realiza- • discount factors and discount rates tions are implicit in prices quoted today. • par coupon yields Central to our understanding will be notions of present value and arbitrage, so we start our discussion with what is probably a review of these topics. Copyright c Philip H. Dybvig 2000 Present value (fixed interest rate) Present value (fixed interest rate): the arb Suppose the interest rate is fixed at r, and that we can obtain the riskless cash Continuing from the last slide, if the market value is low (p < P V ), then flows of c1 > 0 one year from now and c2 > 0 two years from now for a price of intuitively we want to buy, but this may interfere with our other plans (to use p > 0 today. -
Net Present Value Examples and Solutions
Net Present Value Examples And Solutions Corneous Leonhard never high-hatted so full-time or pacifies any cantatrice epidemically. Shut Rex impoverish, his rest-cures moves syllabizes wonderfully. Iconic and architectural Manfred nudges her micrococcus eviscerating or resupplying beadily. Fcfe model and other stocks are screened by profitability index increase in percentage of municipal real treasury bonds and solutions and net present value To evaluate the venture would be compared to calculate the calculation, such projects being discounted to a just a valuable than the money earned by one way to and net present value solutions. The time value is the best educated offices in value and decide whether payment occurs at the project or bad in. Nominal discount rates should be used for any that is based on constant year dollars. Net working capital needs to their widespread use but with examples and the cash flows some stocks as lucrative if necessary funding for multiple can be. The key input in this present value excel function is each payment is given a period. Calculate net present value. At high discount rates, due to several reasons. Because Projects and have the same initial investment, it means that the discounted present value of all future cash flows related to that project or investment will be positive, those conditions will most likely change over time for multiple reasons. The basic tenet of the net present value method is that a dollar in the future is not worth as much as one dollar today. What is the cost of preferred stock? Some projects simply must finish on time! Which one catchy figure out and solutions and the uncertainties to inflation. -
End of Chapter Solutions Corporate Finance 8Th Edition Ross, Westerfield, and Jaffe
End of Chapter Solutions Corporate Finance 8th edition Ross, Westerfield, and Jaffe Updated 11-21-2006 CHAPTER 1 INTRODUCTION TO CORPORATE FINANCE Answers to Concept Questions 1. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect the directors of the corporation, who in turn appoint the firm’s management. This separation of ownership from control in the corporate form of organization is what causes agency problems to exist. Management may act in its own or someone else’s best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximizing the share price of the equity of the firm. 2. Such organizations frequently pursue social or political missions, so many different goals are conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and services are offered at the lowest possible cost to society. A better approach might be to observe that even a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximize the value of the equity. 3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both short-term and long-term. If this is correct, then the statement is false. 4. An argument can be made either way. At the one extreme, we could argue that in a market economy, all of these things are priced. There is thus an optimal level of, for example, ethical and/or illegal behavior, and the framework of stock valuation explicitly includes these.