The bulk of today’s class was spent on the WF Diningcase. While the case itself will soon be forgotten (as it should), I hope that some of the issues that we talked about today stay fresh. In particular, here were some of the central themes (most of which are not original):
Theme 1: The discount rate for a project should reflect the risk of the project, not the risk of the company looking at the project. Hence, it is the beta for restaurants that drives the cost of capital for the dining business, rather than the cost of capital for Whole Foods (or Amazon) as a company. That principle gets revisited when we talk about acquisition valuation… or in any context, where risk is a consideration.
Theme 2: To get a measure of incremental cash flows, you cannot just ask the question, “What will happen if I take this investment?”. You have to follow up and ask the next question: “What will happen if I don’t take the investment? It is the incremental effect that you should count. That was the rationale we used for counting the savings from the parking investment not made in year 12.
Theme 3: If you decide to extend the life on an investment or to make earnings grow at a higher rate, you have to reinvest more to make this possible. In the context of the case, that is the rationale for investing more in capital maintenance in the longer life scenario than in the finite life scenario. Thus, I am not looking for you to make the same capital maintenance assumptions that I did but I am looking for you to differentiate between the two scenarios.
I have put the presentation and excel spreadsheet with my numbers online:
Excel spreadsheet with analysis: http://www.stern.nyu.edu/~adamodar/pdfiles/cfexams/WFDiningAnalysis.xlsx
Please download them. Not only will they be useful to do a comparison of why your numbers may be different from mine but also to get ready for the next quiz.
In the last part of the class, we tied up some loose ends relating to investment analysis, starting with valuing side benefits and synergies and then taking a big picture perspective of the options that are often embedded in project analysis that may lead us to take negative NPV investments.
Post Class Test: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session15test.pdf
Post Class Test Solution: http://www.stern.nyu.edu/~adamodar/pdfiles/cfovhds/postclass/session15soln.pdf