CHAPTER ELEVEN WHERE POSITIVE NET PRESENT VALUES COME FROM Why is an . student who has learned about DCF like a baby with a hammer? Answer: Because to a baby with a hammer, everything looks like a nail. Our point is that you should not focus on the arithmetic of DCF and thereby ignore the forecasts that are the basis of every investment decision. | Brealey-Meyers III. Practical Problems in 11. Where Positive Net The McGraw-Hill Principles of Corporate Capital Budgeting Present Values Come From Companies 2003 Finance Seventh Edition CHAPTER ELEVEN 286 Brealey-Meyers Principles of Corporate Finance Seventh Edition III. Practical Problems in Capital Budgeting 11. Where Positive Net Present Values Come From The McGraw-Hill Companies 2003 WHY IS AN . student who has learned about DCF like a baby with a hammer Answer Because to a baby with a hammer everything looks like a nail. Our point is that you should not focus on the arithmetic of DCF and thereby ignore the forecasts that are the basis of every investment decision. Senior managers are continuously bombarded with requests for funds for capital expenditures. All these requests are supported with detailed DCF analyses showing that the projects have positive How then can managers distinguish the NPVs that are truly positive from those that are merely the result of forecasting errors We suggest that they should ask some probing questions about the possible sources of economic gain. The first section in this chapter reviews certain common pitfalls in capital budgeting notably the tendency to apply DCF when market values are already available and no DCF calculations are needed. The second section covers the economic rents that underlie all positive-NPV investments. The third section presents a case study describing how Marvin Enterprises the gargle blaster company analyzed the introduction of a radically new product. LOOK FIRST TO MARKET VALUES Let us suppose that you have persuaded all your project sponsors to give honest forecasts. Although those forecasts are unbiased they are still likely to contain errors some positive and others negative. The average error will be zero but that is little consolation because you want to accept only projects with truly superior profitability. Think for example of what would happen if you were to jot down your .
