3.1 Evaluating Multiple Projects

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来自 Yonsei University 的课程

Applying Investment Decision Rules for Startups

19 个评分

Yonsei University

Applying Investment Decision Rules for Startups

19 个评分

课程 4（共 5 门，Specialization Valuation and Financial Analysis For Startups）

In the previous course, you learned financial statement analysis and how to make estimate of future financial status. In this course, you are going to learn capital budgeting. That is, how to make an investment decision. You would like to select the best project among various projects you can take. Then, you need to know the criteria. In this course, you are going to learn investment decision criteria such as NPV and IRR, which are most popular decision rules. Using financial analysis and discounted cash flow method, you can make pro forma financial statement and estimate project cash flows. Then, you apply investment criteria to determine whether to invest or not. After learning how to apply NPV and IRR method to investment decision, you are going to learn how to evaluate NPV estimate and scenario, what-if analyses and break-even analysis. In addition to NPV and IRR, you are going to learn Payback period method and Profitability method to determine whether to invest or not when there is a political risk or capital rationing.

从本节课中

Issues in Capital Budgeting

Sometimes you have to evaluate multiple projects at a time. In this module, you will learn how to choose the best project among multiple projects. We will also discuss various important issues in NPV and IRR techniques. Finally, we discuss the fundamental principle in choosing the discount rate.

3.1 Evaluating Multiple Projects5:43

3.2 Comparing NPV and IRR techniques I6:41

3.3 Comparing NPV and IRR techniques II10:58

3.4 Choosing the Discount Rate6:55

与讲师见面

Saeyeul Park
Assistant Professor
School of Business

Hi, so far we have evaluated one project at a time.

However, sometimes we have to evaluate multiple projects.

Let's say you are managing a baseball team and want to sign free agents.

Signing a free agent is a project from the team's perspective.

As there are many free agents available every winter.

The team is evaluating multiple projects at a time

when it is dropping at the free agent market.

In capital budgeting analysis of multiple projects.

You may have multiple independent projects or multiple mutually exclusive projects.

Independent projects are the projects whose cash flows are not affected

by decisions made about other projects.

With multiple independent projects, the acceptance of one project

does not eliminate other projects from further consideration.

That is, all independent projects can be undertaken if they all are acceptable.

On the other hand.

Mutually exclusive projects are the ones where the acceptance of one project

means the others cannot be accepted.

In that sense, mutually exclusive projects compete with one another.

Only one project can be undertaken even if they are all acceptable.

What decision rules should be used when evaluating multiple projects?

If projects are independent, we can just use the same rules we have use For

a single project.

We accept project as long as their NPVs are positive.

Using the payback rule,

we'll accept project if the payback period are shorter than the cutoff period.

Also, using the IRR rule,

we accept project if their IRRs are greater than the discount rate.

What about evaluation of mutually exclusive projects?

If projects are mutually exclusive, only one project can be purchased.

That means, if we use the NPV rule,

we should accept the one with the highest NPV.

Similarly if we use payback rule,

we will choose the product with the shortest payback period.

Finally, the IRR rule will suggest that We choose the one with the highest IRR.

Now let's consider the following two mutually exclusive projects, A and B.

We will get these projects’ NPV and

IRR to determine which project to take.

As we know, they are mutually exclusive.

First, when we apply the discount rate of 10%, the NPV of project A is

about $70 while project B has the NPV of about $57.

What does the NPV rule say?

It says we have to choose the project with the highest NPV.

So our choice is project A, because its NPV is greater than that of project B.

We have also calculated the IRR too.

The IRRs are 13.78% for A and 14.89% for B.

Note that both projects are acceptable

as the IRRs are both greater and the discount rate is 10%.

However, they are mutually exclusive and we can pick only one.

The IRR rule says, we need to choose the project with the greatest IRR and

project B has a higher IRR than A.

Okay, the NPV rule says Project A is better and

the IRR rule says Project B is better, so what should we do?

Generally, the project with a higher NPV also has higher IRR.

Sometimes however, there can be a conflict between NPV rule and

IRR rule, just as we saw in the previous example.

When projects are independent this is not a problem,

because we can just accept all projects.

As long as their NPV are greater than zero or

their IRRs are greater than the discount rate.

But this is a problem when projects are mutually exclusive as we saw earlier.

The general principle in capital budgeting is, that whenever there is

a conflict between NPV and IRR for mutually exclusive projects.

We should always follow the NPV rule.

That is because NPV is the dollar amount of value

that is created by accepting the project.

But IRR is just the rate of return measure.

Let's recall the previous example problem.

By accepting project A, you can increase your firm value by 70 dollars.

If you choose project B, you'll increase your form value by only $57.

The question this principle will asked you is this.

Do you want to increase your firm value by only $57?

When alternatively you can increase it by $70,

just because the higher rate or return number looks fancier.

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