Capital Asset Investment: Strategy, Tactics and Tools

Capital Asset Investment Strategy, Tactics & Tools......Page 4
Contents......Page 8
Preface......Page 16
Acknowledgments......Page 18
Magnitude of capital investment......Page 20
General perspective on capital investment......Page 22
Capital budgeting......Page 24
Cost of capital......Page 25
Risk......Page 26
Uncertainty......Page 27
2 The Objective of capital budgeting......Page 28
A normative model for capital budgeting......Page 29
Operational adaptation......Page 30
Cash flows and the public sector......Page 31
Project types......Page 32
Project characteristics......Page 33
Sunk cost......Page 34
Components of initial cost......Page 35
Useful life......Page 36
Physical deterioration......Page 37
Cash flows......Page 38
Cash inflows (cash receipts)......Page 40
Cash outflows......Page 41
Depreciation......Page 42
Sum-of-the-years’ digits depreciation......Page 43
Example 3.1......Page 44
Example 3.3......Page 45
ACRS Depreciation......Page 46
Canadian depreciation......Page 47
Investment tax credit......Page 48
Inflation......Page 49
Debt......Page 50
Preferred stock......Page 51
Common stock and retained earnings......Page 52
Overall cost of capital......Page 53
Optimal capital structure......Page 55
Cautionary note......Page 57
Payback......Page 58
Weak points of payback......Page 60
Strong points of accounting method......Page 62
Comprehensive example......Page 63
6 Traditional methods that recognize time-value of money: the net present value......Page 66
Unequal project lives......Page 70
Strong points of NPV......Page 72
Weak points of NPV......Page 73
Definition of the IRR......Page 74
Payback and IRR relationship......Page 77
Mathematical logic for finding IRR......Page 78
Interval bisection......Page 79
Newton–Raphson method......Page 80
Investment–financing relationship......Page 81
Clarification of nominal and effective rates......Page 82
IRR with quarterly cash flows......Page 83
Reinvestment rate assumptions for NPV and IRR......Page 84
Conflicting rankings and fisher’s intersection......Page 87
Adjusted, or modified, IRR......Page 91
Summary and conclusion......Page 92
The concept of duality......Page 94
Capital cost......Page 96
Operating inferiority......Page 97
Two basic assumptions......Page 98
Application of the MAPI method......Page 99
The problem of capacity disparities......Page 101
Conclusion......Page 102
Descartes’ rule......Page 104
Example 10.2......Page 105
The Teichroew, Robichek, AND Montalbano (TRM) analysis......Page 106
Example 10.3......Page 108
Example 10.4......Page 110
Example 10.5......Page 111
The unique, real internal rate of return: caveat emptor!......Page 113
Corollary I......Page 115
The Wiar method......Page 116
Example 11.1. An application of the Wiar method......Page 117
Sinking fund methods......Page 118
Initial investment and traditional sinking fund methods......Page 119
Example 11.2......Page 120
Example 11.3......Page 121
Example 11.4......Page 122
Example 11.5......Page 123
The multiple investment sinking fund method......Page 126
Strong points of the methods......Page 127
Weak points of the methods......Page 128
Relationship to other methods......Page 129
Example 11A.1......Page 130
Formal definition and relationship to NPV......Page 133
Payback stage......Page 134
Example 11A.3......Page 135
A brief digression on uncertainty......Page 136
Alleged advantages to leasing......Page 138
Traditional analysis......Page 139
Example 12.1......Page 140
Alternative analysis......Page 141
Analysis......Page 143
Implications......Page 144
Practical perspective......Page 145
Summary and conclusion......Page 146
Appendix......Page 147
Definition and characteristics......Page 150
Example 13.1......Page 151
Example 13.2......Page 152
Example 13.3......Page 156
Conclusion......Page 158
Geometric mean rate of return......Page 160
Example 14.1......Page 161
Time-related measures in investment analysis......Page 163
Boulding’s time spread......Page 164
Macaulay’s duration......Page 165
Unrecovered investment......Page 166
Summary and conclusion......Page 167
The Robichek–Van Horne analysis......Page 168
An alternate method: a parable......Page 170
Comparison to R–VH......Page 174
A dynamic programming approach......Page 175
Summary and conclusion......Page 177
General linear programming approach......Page 178
Contingent projects......Page 180
Zero–one integer programming......Page 181
Example 16.1......Page 183
Goal programming......Page 184
Summary and conclusion......Page 188
16A Appendix to multiple project capital budgeting......Page 189
The concept of utility......Page 196
Attitudes toward risk......Page 197
Calculating personal utility......Page 199
Whose utility?......Page 203
Measures of risk......Page 204
J. C. T. Mao’s survey results......Page 206
Risk of ruin......Page 207
Summary......Page 208
The payback method......Page 210
Example 18.1......Page 211
Certainty equivalents: method II......Page 212
Risk-adjusted discount rate......Page 213
Computer simulation......Page 214
Example 18.3......Page 215
Lewellen–Long criticism......Page 219
Decision trees......Page 222
Example 19.1......Page 224
Example 19.2 A comprehensive simulation example......Page 226
Conclusion......Page 233
Example 20.1......Page 234
Generalizations......Page 235
Project indivisibility......Page 236
Multiple project selection......Page 237
Finding the efficient set......Page 239
The Sharpe modification......Page 241
Epilogue......Page 242
The efficient set of portfolios......Page 244
Enter a risk-free investment......Page 245
The security market line and beta......Page 247
The CAPM and valuation......Page 249
The CAPM and cost of capital......Page 250
Comparison with portfolio approaches......Page 251
Some criticisms of the CAPM......Page 252
The arbitrage pricing theory (APT)......Page 253
Factors—what are they?......Page 254
APT and CAPM......Page 255
Development of the APT......Page 256
22 Multiple project selection under risk......Page 258
Example 22.1: Al’s Appliance Shop, revisited......Page 259
Generalizations......Page 260
Project independence—does it really exist?......Page 261
Project indivisibility: a capital investment is not a security......Page 262
Example 22.2: Noah Zark......Page 263
Generalization on multiple project selection......Page 265
Capital investments......Page 266
Summary and conclusion......Page 267
Acquiring and disposing: the call and put of it......Page 270
Where are real options found?......Page 271
Flashback to PI ratio—a rose by another name. . .......Page 272
Types of real options......Page 273
Real option solution steps......Page 274
Option phase diagrams......Page 275
Complex projects......Page 276
What to expect from real option analysis......Page 277
Identifying real options—some examples......Page 278
The binomial option pricing model......Page 279
Example 23.1 Value of strategic flexibility in a ranch/farm......Page 281
A game farm, recreational project......Page 283
Case 1: 100 percent switch......Page 284
Case 2: Mix operation......Page 285
Option to abandon for salvage value......Page 286
The option to expand operation (growth option)......Page 287
Interaction among strategic options......Page 288
Contingent claim valuation:......Page 289
The optimal exercise of the growth option and firm value......Page 290
The abandon option and firm value......Page 291
Conclusion......Page 292
Appendix: Financial mathematics tables and formulas......Page 294
A.1 Single payment compound amount. To find F for a given P......Page 295
A.2 Single payment present worth factor. To find P for a given F......Page 302
A.3 Ordinary annuity compound amount factor. To find F for a given R received at the end of each period......Page 310
A.4 Ordinary annuity present worth factor. To find P for a given R received at the end of each period......Page 318
Bibliography......Page 326
Index......Page 334