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3.1. Why use NPV as a criterion of the choice of projects?

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Principles of Corporate Finance – A Tale of Value

モスクワ物理工科大学（Moscow Institute of Physics and Technology）

5 (7 件の評価) | 1.6K在籍する学生

Understanding Modern Finance 専門講座における 5 の 2 コース

The study of Corporate Finance seems to be a very generic part of business education. Still, it either falls in the trap of intimidating formulas or is superficially journalistic. Both extremes preclude the understanding of the core finance ideas, concepts, and models. This Course is an attempt to avoid the above extremes. We discuss the core basis and mechanisms of modern corporate finance in a learner-friendly way. We will analyze the market’s most fundamental problems, realize the intrinsic interests and preferences of investors, reveal the true meaning of specific financial terms, and uncover important issues that are so often ignored in choosing and valuing investment projects. The learners will gain insight into the essence of corporate finance. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses.

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5 (7 件の評価)

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Making the Choice of Good Investment Projects. NPV and Other Criteria. Why Is NPV Better?

We start Week 3 of the Course by the discussion of criteria of choosing investment projects. Beside NPV, the internal rate of return (IRR) and other approaches are introduced. We show why the NPV criterion is the best and why the application of others may lead to wrong investment decisions. Then we focus on the main ideas to be taken into account while setting up cash flow patterns and making the choice of project on the basis of NPV. We mention some special issues – relevant costs, depreciation, inflation. We present the concept of equivalent annual cost (EAC) as a method of comparing projects of different length. Then we study the application of EAC in greater detail in a case.

3.1. Why use NPV as a criterion of the choice of projects?5:53

3.2. Other criteria – pluses and minuses8:26

3.3. Internal rate of return (IRR)8:28

3.4. Problems with IRR – it’s not exactly like NPV!12:52

3.5. Using NPV – what should we know3:58

3.6. NPV and cash flows. Some accounting details11:39

3.7. Sunk costs – opportunity costs – relevant costs10:55

3.8. Depreciation – an overview relevant to cash flows5:51

3.9. Discount rates – nominal and real. The role of inflation6:02

3.10. Projects of different length. Equivalent annual cost (EAC)9:32

3.11. EAC – an example11:58

3.12. Conclusions and unanswered questions10:15

講師

Konstantin Kontor
Director and Professor of Finance and Strategy

字幕

Welcome, everyone, to the third week of a corporate finance course. In the previous weeks, we've introduced the NPV criterion as the most fundamental approach to labeling projects as good or bad. And in the second week, we applied that to some most important projects, or securities, given that all the inputs for these formulas are known. And if we knew these inputs in reality, then we would be all set. We would not need anything else to do, but unfortunately reality is vaguer. And this week, what we will do, we will try to apply the NPV criterion to the more realistic cases, in which our major job would be to treat the inputs properly. We will not pretend to know them with certainty, which is unrealistic because they are taken from the future. Nor will we pretend to say that the interaction of the projects or any other risks that are there, they cannot change them. But what we will pretend, we will try to treat them properly and try to tackle all the challenges that occur on this way. When it comes to the use of the NPV criterion, we will have to deal with cash flows and discount rates. Our study of the details of discount rates is postponed till week four, but it is in this week that we will take into account certain specific features of these Rs. Not with the same level of derealization as we used in the second week when we talked about bonds, but with respect to consistency. Because oftentimes people are tempted to use different rates with different pieces of cash flows. And if it's done inconsistently, that may result in significant mistakes. Now, we will start this discussion with the following. Let's say that we are about to use NPV in reality. We have to tackle the following challenges. First of all, why is it better? Two, how to use it? And I would also say, number three, what about inputs? You may say that I am repeating myself to an extent. Well, this is the correct observation, but it's so important that I'm emphasizing that once again. So we will proceed in the following way. First of all, in a couple of episodes, we will discuss why NPV's a better criteria than others. Because one thing why it's not so widely beloved by the people is that it requires some thinking. And it requires the answers to these second and third question, like how exactly we use it, and what do we do with the inputs? Because they are not only uncertain, but they have to be treated consistently. And then the next thing here, we will also study challenges, To NPV use. Not to NPV as a concept, but to NPV use. And here we will deal with the fact that most inputs are taken from accounts, so I would put accounting. And accounting, as you might remember, normal is for outsiders or for the managers, dependent upon whether it's financial accounting or managerial accounting. And we study the details of that in our third course, that is devoted specifically to some accounting issues and how they are properly applied in finance. And then, we also have to take into account the idea of time horizons. Because sometimes people are tempted to prefer some short-term decisions, and that sometimes is called with the famous buzzword of management, myopia. But we will see exactly why that happens. So that is going to be our game plan. And in what follows we will start to see why this is a better criterion. And in order to do so, we will have to compare with some other possible criteria. We will not designate them as straightforwardly bad, but we will see deeper. And see exactly what these approaches that are somewhat easier to use, what they ignore, and why not realizing this idea of ignoring something may be extremely damaging. So this comparison we will start in the next episode.

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