《空中交通运输系统》（英文版）chapter 20 business case

Closing the Business Case Prof John -Paul Clarke 16.886 Air Transportation Systems Architecting prl21,2004 A

Closing the Business Case Prof. John-Paul Clarke 16.886 Air Transportation Systems Architecting April 21, 2004

The top 5 investor questions How much will i need to invest? How much will i get back? When will i get my money back? How much is this going to cost me? How are you handling risk uncertainty?

The top 5 investor questions • How much will I need to invest? • How much will I get back? • When will I get my money back? • How much is this going to cost me? • How are you handling risk & uncertainty?

nvestment criteria Net present value Payback Discounted payback Average return on book value Internal rate of return

Investment criteria • Net present value • P a y b a c k • Discounted payback • Average return on book value • Internal rate of return

Net present value(NPV) Measure of present value of various cash flows in different periods in the future Cash flow in any given period discounted by the value of a dollar today at that point in the future “ Time is money a dollar tomorrow is worth less today since if properly invested, a dollar today would be worth more tomorrow Rate at which future cash flows are discounted is determined by the discount rate" or "hurdle rate Discount rate is equal to the amount of interest the investor could earn in a single time period (usually a year)if he/she were to invest in a"safer" investment

Net present value (NPV) • Measure of present value of various cash flows in different periods in the future • Cash flow in any given period discounted by the value of a dollar today at that point in the future – “Time is money” – A dollar tomorrow is worth less today since if properly inv ested, a dollar today would be worth more tomorrow • Rate at which future cash flows are discounted is determined by the “discount rate” or “hurdle rate” – Discount rate is equal to the amount of interest the investor could earn in a single time period (usually a year) if he/she were to invest in a “safer” investment

Calculating NPv Forecast the cash flows of the project over Its economic life Treat investments as negative cash flow Determine the appropriate opportunity cost of capital Use opportunity cost of capital to discount the future cash flow of the project Sum the discounted cash flows to get the net present value(NPv) NPV=C+ 1+r +

Calculating NPV • Forecast the cash flows of the project over Its economic life – Treat investments as negative cash flow • Determine the appropriate opportunity cost of capital • Use opportunity cost of capital to discount the future cash flow of the project • Sum the discounted cash flows to get the net present value (NPV) NP V = C 0 + C1 1 + r + C 2 ( ) 1 + r 2 + K + CT ( ) 1 + r T

NPV example Period Discount factor Cash F| ow Present∨aue 0 150.000 150.000 0.935 100000 93500 0.873 +300000 +261,000 Discount rate =7% NPV= $18,400

NPV example Period Discount Factor Cash Flow Present Value 0 1 -150,000 -150,000 1 0.935 -100,000 -93,500 2 0.873 +300000 +261,000 Discount rate = 7% NPV = $18,400

Points to keep in mind about nPv Assumes only one course of action Reasonable assumption if conditions are stable No room for managerial flexibility Choice of the discount rate is difficult Typically, use a combination of equilibrium models(like CAPM)and"expert judgment Should always perform sensitivity analysis on discount rate

Points to keep in mind about NPV • Assumes only one course of action: – Reasonable assumption if conditions are stable – No room for managerial flexibility • Choice of the discount rate is difficult: – Typically, use a combination of equilibrium models (like CAPM) and “expert judgment” – Should always perform sensitivity analysis on discount rate!

Payback ·| nvestment decision based on“ time it takes to recover investment No discounting of cash flows Gives equal weigh ht to cash flows before cut-off date no weight to cash flows after cut-off date Cannot distinguish between projects with different NPV Difficult to decide on appropriate cut-off dat

Payback • Investment decision based on “time it takes to recover investment” • No discounting of cash flows • Gives equal weight to cash flows before cut-off date & no weight to cash flows after cut-off date • Cannot distinguish between projects with different NPV • Difficult to decide on appropriate cut-off date

Payback example Project C NPV@10% Payback 2.000+1.000+1.000+5000 3,492 2 ABc 2.000 0+2000+5000 3.409 2,000+1,000+1,000+100,000 74.867

Payback example Project C 0 C1 C 2 C 3 NPV @ 10% Payback A -2,000 +1,000 +1,000 +5,000 3,492 2 B -2,000 0 +2000 +5,000 3,409 2 C -2,000 +1,000 +1,000 +100,000 74,867 2

Discounted payback Payback criterion modified to account for the time value of money Cash flows before cut-off date are discounted Surmounts objection that equal weight is given to all flows before cut-off date Cash flows after cut-off date still not given any weight

Discounted payback • Payback criterion modified to account for the time value of money – Cash flows before cut-off date are discounted • Surmounts objection that equal weight is given to all flows before cut-off date • Cash flows after cut-off date still not given any weight