Finance II
Corporate Finance

Investment Selection Criteria and NPV

Corporate Finance:
Raise cash in financial market, invest into firm's ops, have the result of investment, reinvest or give dividents.

Accounting Notions:
Types of Financial Statements:
-Balance Sheet: Asset = Liabilities + Stockholders' equity

Net Working Capital = Current Assets – Current Liabilities . It is the capital needed to keep the company running.

Earnings differs from cash flows. In the latter, you must add back non-cash expenses (Depr. And Amort.) and deduct investment expenses and changes in the net working capital.

Retained Earnings = Net Income – Dividends

Investment Appraisal Methods:
Should we invest in all? How to choose between mutually exclusive projects.

Investment Project Selection Criteria

1-NPV:
Ra: reflects the risk of the project and can be assessed by looking into projects with similar risk. If NPV greater than 0, it's a go.
-Properties: Time value of money, NPV depends on expected free cash flow and on the rate of the project, NPV is additive (NPVAB=NPVA+NPVB)

2-Book rate of return= Book income/Book asets.
It is an accounting measure, it depends on how the accountant classifies the CF. The components reflect tax and accounting figures, not CF. It is not project specific, it reflect the whole company. It ignores the time value of money and it is rarely used.

3-Payback period: It is the number of years it takes the company to recover the investment. We only execute if the period is less than the pre-specified. The disadvantages is that it ignores CF that occur after pre-specified period and it does not consider the time value of money, since it gives equal weight to all CF.

4-Internal Rate of Return
IRR is the discount rate that equal NPV to 0. We execute if IRR is greater that opportunity cost Ra.

IRR Pitfalls:
1-Lending or