Introduction to Corporate Finance

9: Capital Budgeting Process and Decision Criteria

example

What are the NPVs of each of the investment opportunities now facing Global Untethered? Time lines

depicting the NPV calculations for Global Untethered’s projects appear in Figure 9.3. Discounting each

project’s cash flows at 18% yields the following results:

NPV $250

$35

1.18

$80

1.18

$130

1.18

$160

1.18

$175

1.18

WesternEurope 12345 $75.^3

( ) ((()))( )

=− + ++++=

NPV $50

$18

1.18

$22

1.18

$25

1.18

$30

1.18

$32

1.18

South-esternAustralia 12345 $25.^7

( ) ((()))( )

=− + ++++=

Both projects increase shareholder wealth, so both are worth undertaking. One could say that both

projects outperform the company’s 18% required return, and are therefore acceptable. However, if the

company can make only one investment, it should choose to expand its presence in Western Europe. That

investment increases shareholder wealth by $75.3 million, whereas the South-eastern Australian investment

increases wealth by only about one-third as much. If Global Untethered has 100 million ordinary shares

outstanding, then accepting the Western Europe project should increase the share price by about $0.75 ($75.3

million ÷ 100 million shares). Accepting the South-eastern Australian investment would increase the share price

by almost $0.26 ($25.7 million ÷ 100 million shares).

FIGURE 9.3A NPV OF GLOBAL UNTETHERED’S PROJECTS AT 18% ($ MILLIONS): WESTERN EUROPE PROJECT

The net present value (NPV) of Global Untethered’s Western Europe project is $75.3 million, which means that it is

acceptable (NPV > $0) and therefore creates wealth for shareholders.

0 1 2 3 4 5

End of year

NPV = $75.3

–$250 $35 $80 $130 $160 $175

29.7

57.5

79.1

82.5

76.5

Formula B8:

–250 + NPV(B7,B2,B3,B4,B5,B6)

Net present value $75.3

Cash flow 2

18%

–250

35

80

Cash flow 1

Cash flow 0

Row

Column

Spreadsheet

1

2

3

(^4) Cash flow 3 130
(^5) Cash flow 4 160
(^6) Cash flow 5 175
7 Interest
8
9
A B