See: Net Present Value.
You run a business selling colored ostrich eggs for Easter. You have some money saved up and want to invest in the company’s growth. There are a few possible opportunities. You could buy a smaller rival that specializes in emu eggs. You could launch a new product, providing cooked ostriches for Thanksgiving dinners.
The stat known as net present value of growth opportunities lets you know which of these potential options to take. To use the figure, you calculate the net present value for each of the potential investments. The process basically boils down each opportunity into a single figure.
Once you have the NPVGO, making the decision becomes easy. If purchasing the emu egg distributor has a NPVGO of $15 million and the ostrich meat product has a figure of $20 million, the ostrich meat product becomes the obvious place to invest.
The NPVGO equation starts by estimating the amount of cash the opportunity will bring in. Then this figure is discounted to take into account a company's cost of capital (which represents the minimum return the company could get by not choosing any investment, and just loaning the money out at market rates). From this, subtract the amount it took to launch the opportunity (either the amount to purchase the competitor or the money you had to invest in the launch product).
Related or Semi-related Video
Finance: What are Time-Weighted Rate Of ...1 Views
Finance allah shmoop what are time and risk waited rates
of return a dollar today is worth more than a
dollar tomorrow Like that's the central prayer of the financial
force Here's the gist You've double your money in an
investment Is that good Bad ugly mon We need a
whole lot more information here Tto answer Did you buy
thirty eight million and two dollars worth of lottery tickets
and that last two dollar ticket got you seventy six
million in winnings Was that like a good investment Or
how about this You took thirty six years to double
your money Was that good I answer to both No
not at all The lottery ticket example is a risk
waited return The lottery famously takes advantage of ignorant people
spending their hard earned money on tickets representing dreams but
which have horrible odds of any kind of decent pay
back But the lottery makes go into a vegas casino
look like actually a good deal so you may win
but it's a bad risk no matter how you look
at it And hey somebody has to pay those teacher
pension bill So why shouldn't it be people who didn't
graduate high school Right Well the time waiting is a
big deal to in a world where the stock market
broadly speaking doubles on its own About every eight nine
ten twelve years Something like that This calculation is done
over very long periods of time and it's held true
for about a century and change in america So if
he took thirty six years to double your money well
it implies you only made two percent a year as
your rate of return Remember that rule of seventy two
thing Yeah that right there Seventy two divided by thirty
six and you get a whopping two percent return Well
in that same period of time the market might have
doubled in four times So the ten grand that double
to be twenty grand in thirty six freakin years under
your watch we'll have you just put it into an
index fund of the s and p five hundred over
that same time period Well it would have doubled once
along the timeline here to be twenty grand then doubled
again here to be forty grand and then doubled again
here to be a tigre rine and then ah forthe
doubling right here after thirty six years maybe one hundred
sixty grand And that's just an index fund Nothing fancy
Not warren buffett Just a basic vanilla index fund that
anyone with two hundred fifty bucks in their pocket can
buy And it's worth noting dividends which often get ignored
in the financial press actually matter a ton when it
comes to the calculation of long term investment results Generally
speaking that continued payment of dividends is a low risk
adventure Very few companies ever cut or fully do away
with their dividends And if they do well it means
a pretty much everything is rotten in denmark so you
can count on dividends The bolster overall returns that historically
dividends have had a wide range of somewhere between two
and seven or eight percent for the mid range of
the s and p five hundred But if you pegged
them around and three ish percent today and changed to
reflect the modern era well then the overall market need
only compounded about five percent To deliver that five plus
three percent and change eight ish percent total returns That
will allow the stock market to double about every nine
years or so right so we're ignoring taxes here but
we're ignoring the use of dividends proceeds to buy more
shares every quarter as well when those dividends air paid
So when you think about time and risk think about
them like they're a kind of financial stone soup which
when mixed together with the right spices of tax hedges
leverage and a bull market well make a really nice
retirement meal and you don't even need your teeth on 00:03:22.773 --> [endTime] a bonus
