Download Class 2

Survey
yes no Was this document useful for you?
   Thank you for your participation!

* Your assessment is very important for improving the work of artificial intelligence, which forms the content of this project

Document related concepts

Value proposition wikipedia, lookup

Channel coordination wikipedia, lookup

Strategic management wikipedia, lookup

Shareholder value wikipedia, lookup

Business valuation wikipedia, lookup

Foreign market entry modes wikipedia, lookup

Columbia Business School wikipedia, lookup

Transcript
Investment Strategy
April 11, 2007 (LA)
or April 5, 2007 (OCC)
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Strategic Issues raised by NPV
 Sources
of NPV
 Sequencing of decisions
 Dealing with uncertainty
 Open questions
– the discount rate
– affecting the market value for investors
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Sources of Present Values
 Michael
Porter’s analysis (e.g. Competitive
Strategy, 1980)
–
–
–
–
–
Competitors
Suppliers
Customers
Substitutes
Potential entrants
 No
advantage lasts forever in competitive
markets
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Sequencing of Decisions
 Most
investments can be developed in a
sequence of stages where the investment
strategy can be refined or the project
abandoned
Good result
 Decision trees useful
Good result
Expand
Test Market
Bad result
Bad result
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Close Down
Stewart Pharmaceuticals
The Stewart Pharmaceuticals Corporation is considering
investing in developing a drug that cures the common cold.
 A corporate planning group, including representatives from
production, marketing, and engineering, has recommended
that the firm go ahead with the test and development phase.
 This preliminary phase will last one year and cost $1 billion.
Furthermore, the group believes that there is a 60% chance
that tests will prove successful.
 If the initial tests are successful, Stewart Pharmaceuticals can
go ahead with full-scale production. This investment phase
will cost $1.6 billion. Production will occur over the next 4
years.

J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Decision Tree for Stewart
Pharmaceutical
The firm has two decisions to make:
To test or not to test.
To invest or not to invest.
Success
Test
Invest
NPV = $3.4 b
Do not
invest
NPV = $0
Failure
Do not
test
NPV  $0
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Invest
NPV = –$91.46 m
Stewart Pharmaceutical: Test?
 Let’s
move back to the first stage, where the decision
boils down to the simple question: should we invest?
 The expected payoff evaluated at date 1 is:
Expected
payoff
Payoff
Payoff
 Prob.
  Prob.
  
 


 sucess given success   failure given failure
Expected
payoff



 .60  $3,433.75  .40  $0  $2,060.25
• The NPV evaluated at date 0 is:
NPV  $1,000 
$2,060.25
 $872.95
1.10
So we should test.
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Dealing with Uncertainty
 We
have implicitly been dealing with
expected cash flows - each cash flow
represents a probability-weighted average
of likely outcomes
 Alternatives methods are to deal with
several alternatives (scenario analysis) or to
identify critical assumptions (sensitivity
analysis)
 Break-even points may assist evaluation
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Break-Even Analysis
 Accounting
break-even analysis
Accounting Breakeven 
 Present-value
Fixed Costs  Depreciati on
Gross M arg in
break-even analysis
EAC  Fixed Costs * (1  Tc )  Depreciati on * Tc
Pr esent  Value Breakeven 
Gross M arg in * (1  Tc )
 Example
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Examples of PV vs Real Options
Value of motel is costing $9.7 million expected
worth $10 million at 10% yields NPV of $300,000
 $10 million is expected value of two equally likely
outcomes, $11 and $9 million, future will reveal
information about true value of motel
 Management could wait one year to take
advantage of this information
 This value of project with option to postpone is
.5*($1.3)/1.1 = $ .591 million (since no bad
outcome) so option value is $ .591 - $ .300 =
$.291 million

J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Management options
Abandon
Contract
Switch
Wait
Expand
Growth
Currently Invested: React to Bad News
Not Currently Invested
Currently Invested: React to Good News
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Real Options and Investment
 Growth
options
– May increase size of investment later
 Timing
options
– Delay and learn more about opportunities
 Switching
options
– Change nature or use of invested assets
 Option
to expand or contract (scale)
 Abandonment options
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
Open Questions
 How
do we actually choose the discount
rates?
 If we make positive net present value
decisions, how will they affect our share
price?
 Can the market understand every possible
strategy -- should we play out a strategy
even though our share price suffers?
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007
For Class 11 and Following Week
 Read
Chapters 9 and 10 and work problems
for next week
 Work on Part 3 of group project (due April
25 (LA) or April 24 (OCC)) and identify
any questions or problems requiring
assistance from instructor
 Read handout on Sheet 2 “Continuing
Values” assumptions for PVFIRM05
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2007