 Present Value, Capital Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 2 2009 © The McGraw-Hill Companies,

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1  Present Value, Capital Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 2 2009 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill

2 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 2 Topics Covered  Present Value  Net Present Value  NPV Rule  ROR Rule  Opportunity Cost of Capital  Managers and the Interests of Shareholders

3 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 3 Present Value Value today of a future cash flow. Discount Rate Interest rate used to compute present values of future cash flows. Discount Factor Present value of a $1 future payment.

4 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 4 Present Value

5 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 5 Present Value Discount Factor = DF = PV of $1 atau Rp1 Discount Factors can be used to compute the present value of any cash flow.

6 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 6 Valuing an Office Building Step 1: Forecast cash flows Cost of building = C 0 = 350 Sale price in Year 1 = C 1 = 400 Step 2: Estimate opportunity cost of capital If equally risky investments in the capital market offer a return of 7%, then Cost of capital = r = 7%

7 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 7 Valuing an Office Building Step 3: Discount future cash flows Step 4: Go ahead if PV of payoff exceeds investment

8 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 8 Net Present Value

9 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 9 Risk and Present Value  Higher risk projects require a higher rate of return.  Higher required rates of return cause lower PVs.

10 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 10 Risk and Present Value

11 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 11 Present Value  PV=Cn/(1+r) n  TPV=Σn Cn/(1+r) n  Jika perkiraan penerimaan hasil usaha selama 5 tahun ke depan: 50, 75,100,150,200. Rate bunga pinjaman 10%. Berapa TPV?  NIlai Nominal Total Penerimaan=575  Nilai Riil Penerimaan (PV)=

12 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 12 Rate of Return Rule  Accept investments that offer rates of return in excess of their opportunity cost of capital

13 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 13 Rate of Return Rule  Accept investments that offer rates of return in excess of their opportunity cost of capital. Example In the project listed below, the foregone investment opportunity is 12%. Should we do the project?

14 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 14 Net Present Value Rule  Accept investments that have positive net present value

15 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 15 Net Present Value Rule  Accept investments that have positive net present value. Example Suppose we can invest $50 today and receive $60 in one year. Should we accept the project given a 10% expected return?

16 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 16 Opportunity Cost of Capital Example You may invest $100,000 today. Depending on the state of the economy, you may get one of three possible cash payoffs:

17 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 17 Opportunity Cost of Capital Example - continued The stock is trading for $95.65. Depending on the state of the economy, the value of the stock at the end of the year is one of three possibilities:

18 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 18 Opportunity Cost of Capital Example - continued The stocks expected payoff leads to an expected return.

19 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 19 Opportunity Cost of Capital Example - continued Discounting the expected payoff at the expected return leads to the PV of the project.

20 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 20 Investment vs. Consumption  Some people prefer to consume now. Some prefer to invest now and consume later. Borrowing and lending allows us to reconcile these opposing desires which may exist within the firm’s shareholders.

21 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 21 Investment vs. Consumption A B 100 80 60 40 20  406080100 income in period 0 income in period 1 Some investors will prefer A and others B

22 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 22 Investment vs. Consumption The grasshopper (G) wants to consume now. The ant (A) wants to wait. But each is happy to invest. A prefers to invest 14%, moving up the red arrow, rather than at the 7% interest rate. G invests and then borrows at 7%, thereby transforming $100 into $106.54 of immediate consumption. Because of the investment, G has $114 next year to pay off the loan. The investment’s NPV is $106.54-100 = +6.54

23 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 23 Investment vs. Consumption  The grasshopper (G) wants to consume now. The ant (A) wants to wait. But each is happy to invest. A prefers to invest 14%, moving up the red arrow, rather than at the 7% interest rate. G invests and then borrows at 7%, thereby transforming $100 into $106.54 of immediate consumption. Because of the investment, G has $114 next year to pay off the loan. The investment’s NPV is $106.54- 100 = +6.54 100 106.54 Dollars Now Dollars Later 114 107 A invests $100 now and consumes $114 next year G invests $100 now, borrows $106.54 and consumes now.

24 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 24 Managers and Shareholder Interests  Tools to Ensure Management Responsiveness  Subject managers to oversight and review by specialists.  Internal competition for top level jobs that are appointed by the board of directors.  Financial incentives such as stock options.

25 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 25 Risk Factor  Resiko selalu ada dalam kegiatan usaha / investasi; karena selalu harus melakukan perkiraan cashflow hasil investasi di masa datang  Resiko adalah kemungkinan timbulnya kerugian yang dapat diperkirakan sebelumnya dengan memakai data dan informasi yang relevan

26 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 26 How Risk could come out 1.Besar Investasi: semakin besar investasi semakin besar resikonya. Dapat membuat perusahaan bangkrut. 2.Investasi yg relatif kecil mempunyai resiko yang relatif kecil pula. Tidak mengganggu operasional perusahaan 3.Cashflow Re-investment: pilihan antara perkiraan return dan lama return akan terjadi 4.Variasi Cashflow dari berbagai sumber. Semakin bervariasi, semakin besar resikonya.

27 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 27 Capital 1.Setiap usaha membutuhkan dana sebagai modal /capital 2.Modal berasal dari modal sendiri atau pinjaman pihak lain. 3.Setiap dana yg digunakan untuk usaha ada biayanya: bunga, notaris, meterai,dsb 4.Biaya modal tersebut berfungsi sebagai cut of rate / pembatas apakah jadi invest atau tidak.

28 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill 2- 28 Capital Cost 1.Biaya hutang. Termasuk bunga dan biaya lain untuk perusahaan yg mengeluarkan obligasi 2.Cost of preferred stock: pemilik saham preferen mempunyai hak untuk memperoleh dividen secara teratur, bahkan bila perusahaan merugi 3.Cost of Common stock: pembayaran dividen Semakin meningkat jika laba semakin baik 4.Rate biaya modal dihitung secara tertimbang (Weighted Average Cost of Capital atau WACC)