Slide Show #15Slide Show #15AGEC 430

Macroeconomics of Agriculture

Spring 2010

Handout #24Handout #24

Project is economically feasible since the NPV > 0.

Project is economically feasible since the NPV > 0.

NPV = NCF1 / (1+R) + …. – C. Here, NPV = 1,750 / (1+R) + … - CNPV = NCF1 / (1+R) + …. – C. Here, NPV = 1,750 / (1+R) + … - C

If a startup investment, then NPV = 8,250 / (1+R) + … - C If a startup investment, then NPV = 8,250 / (1+R) + … - C

A measure of business riskA measure of business risk

A better measure of business riskA better measure of business risk

This equation is an enhancement of equation (2) since it allows for the presence of changing business risk exposure over the economic life of the investment.

This equation is an enhancement of equation (2) since it allows for the presence of changing business risk exposure over the economic life of the investment.

Leverage ratioLeverage ratio

Therefore the required rate of return to use in the NPV model is in a given year is given by:

RRR = risk free rate + business risk premium + financial risk premium

Therefore the required rate of return to use in the NPV model is in a given year is given by:

RRR = risk free rate + business risk premium + financial risk premium

NPV Model for Our ClassNPV Model for Our Class

NPV = NCF1/(1+R1) + NCF2 /[(1+R1)(1+R2)] + … + Tn/[(1+R1)(1+R2)…(1+Rn)] - C

where:NCFi = net income + depreciation in the ith yearRi = required rate of return reflecting interest rate and both business and financial risk premium in the ith yearTn = terminal value at the end of the economic lifeC = cost of the investment project

For the purposes of our course, you are simply asked to assume a total risk premium that fits your teams attitude towards risk and your perceived exposure to risk. All calculations are handled by the model.

For the purposes of our course, you are simply asked to assume a total risk premium that fits your teams attitude towards risk and your perceived exposure to risk. All calculations are handled by the model.

Presentation ModelPresentation ModelThe model given to each presentation

team should reflect your team’s aversion to risk.

It will calculate the risk-adjusted net present value for you.

Your task will be to interpret the change in the net present value as conditions change in the Lower Slobovian economy.

Since NPV > 0, the investment is deemed economically feasible.Since NPV > 0, the investment is deemed economically feasible.

The impact of your shock is captured here.

The impact of your shock is captured here.