PROJECT INTERACTIONS

Erosione.g., diet and regular soft drinks

Enhancemente.g., “The Lion King” & merchandising

Contingent Projectse.g., need road to develop mine

Mutually Exclusive Projectse.g., replacement equipment

PRESENT VALUE OF AN ANNUITY

1. PERPETUITY STARTING NEXT PERIOD

PMT PMT PMT PMT PMT PMT

PV =PMT/r

2. PERPETUITY STARTING AT n

PMT PMT PMT PMT

PV = (PMT/r)/(1+r)n

PV OF N-period annuity = PMT/r - (PMT/r)/(1+r)n =(PMT/r)(1-1/(1+r)n)

ANNUITY PV (CONT.)

• Given annuity PMT, r and n, we can find PV

• Given annuity PV, r and n, we can find PMT

• EAC technique converts an uneven stream into an annuity with same PV

1)r1(

)r1(rPVPMT

)r1(r

1)r1(PMT

)r1(

11

rPMTPV

n

n

n

n

n

INFLATION & CAPITAL BUDGETING

nr

nr

r

r1

nnr

nnr

r

r1

rn

)r1(

CF...

)r1(

CF

)i1()r1(

)i1(CF...

)i1)(r1(

)i1(CFPV

)i1)(r1()r1(

nr

nr

r

r1

nnr

nnr

r

r1

rn

)r1(

CF...

)r1(

CF

)i1()r1(

)i1(CF...

)i1)(r1(

)i1(CFPV

)i1)(r1()r1(

INFLATION & CAP. BUD. (cont.)

To calculate NPV with inflation:Discount nominal cash flows at nominal

discount rate

ORDiscount real cash flows at real discount rate

Watch out for depreciation tax shields

INVESTMENT OPTIONS

Be aware of future choices (options) that might be associated with projects - these can add to the value of the projectFuture investment optionsAbandonment optionPostponement option