0:52

Why? Because you worry about them only for

Â tax reasons.

Â After that, you've gotta add or subtract, if you've subtracted or added.

Â The second issue to worry about is working capital.

Â And remember working capital is coming from again two forms,

Â 1:28

I apologize for that slip up.

Â I meant total capital broken up into two parts.

Â Capex and working capital come from balance sheet.

Â And remember, therefore you have to think about changes.

Â 1:48

Think about accounting a lot more than this.

Â I have emphasized earlier, that this is the one area

Â where this course couldn't possibly do justice, and the reason is,

Â you have to spend as much time you have understanding accounting as you've

Â done on this course, if you want to dig deeper into understanding the details.

Â Having said that, and exposing you enough that you'll be able to understand

Â what's going on, and do more accounting based on what you'll need okay?

Â 2:27

We have done three principles, I have a couple more to go.

Â Important principle, very important,

Â do not mix financing with operations.

Â And I think I tried to emphasize this earlier,

Â that while you are doing project analysis, stay here.

Â While you are doing project analysis, please stay on the asset side,

Â because these assets give you cash flows and

Â then we later worry about what the discount rate is.

Â But the value is generated on the asset side of the balance sheet and

Â this is extremely important.

Â 3:02

So think about it this way, if you start thinking about financing while

Â doing project analysis, you're worrying about an issue that doesn't add value.

Â What adds values is whether your idea is good or not?

Â 3:19

And you'll see later that this guy over here will reflect your financing.

Â So you already going to take it into account when you're going to discount

Â the cash flows.

Â So when you do project analysis, stay out of financing.

Â So there is a famous song Can't Touch This,

Â it's by MC Hammer and just Google MC Hammer.

Â Every time your hand goes in this direction and

Â starts worrying about financing, just say can't touch this.

Â 3:57

This is the one time I want you to be in my class physically because I really think

Â things like that, make you remember things more than my saying you know

Â necessarily only conceptual argument.

Â But basically when you're in project analysis, don't worry about financing.

Â And the reason is two.

Â One, money is not generated by financing, money is generated by your ideas.

Â Second, when you are discounting your cashflow,

Â you're taking financing into account.

Â I'll give you a third one which will help.

Â 4:30

Your ideas generates cash flows and financing just divides up the cash flows.

Â So, for example, if you have only equity, only owners,

Â only shares, all the money goes to them.

Â If you have debt and equity,

Â we'll see next to it that gets paid first than equity.

Â So the cash flow that shared in financing, they don't create value.

Â Okay? Very important.

Â 5:01

In V actually have, sorry.

Â Model one probably include the effects of inflation/deflation.

Â This is relatively easy but it's a very common error.

Â What do I mean by that?

Â When you are doing C1, when you are doing.

Â 5:21

When you're doing C1, C2, and so on, remember these are your cash flows.

Â Right?

Â Remember, underlying this is for revenues, for example, just take an example.

Â It's price x quantity.

Â P1, P1.

Â Price x quantity, P2 and so on.

Â When you are projecting the prices please remember inflation.

Â 5:47

Because if you do not inflation and inflation usually happens or deflation for

Â example laptops, do the prices for the same kind of laptop increase or decrease?

Â Decrease over time.

Â So I'm not necessarily mean inflation.

Â I see inflation or deflation.

Â If you don't take the prices into account, you will be making a big mistake.

Â And the reason is, when you discount, your R has inflation

Â in it without question, except when clarified in a particular context.

Â And it has other stuff, which I call real stuff.

Â But inflation is always in the R.

Â So you're going to discount based on inflation, but

Â if you haven't built an inflation, then you have a problem, right?

Â And one last comment about inflation.

Â Every item in your accounting statement, or

Â your cash flow statement rather, has a different inflation.

Â So your revenues may be growing at 10%, but

Â your cost of goods sold may be growing at a slower rate, or faster.

Â Why? Because one is a supply and input and

Â the other is a demand based output.

Â And they're different animals.

Â Right?

Â So the inflation and everything is not constant.

Â So when you do a detailed analysis, always think of inflation and for

Â different things.

Â One last comment.

Â It used to be a very tough thing to do.

Â Why?

Â Because there's no computing ability 40 years ago to do even one line item.

Â But now you have prices on everything available and

Â you do serious analysis based on line items depending on a business, of course.

Â If there's a lot of availability and

Â inflation in different items of your business you take them into account,

Â if they're similar, then you don't, but you have to think about it.

Â 7:55

And for today before I forget to emphasize,

Â I'm going to stick with the ten year project.

Â When we start next time we'll talk about bond and stocks and

Â the main difference is bond have a finite life and stocks have infinite life.

Â 8:11

So, what I'm going to introduce is the notion of what do you do after

Â the ten years of the project?

Â Like I said that one principle is worry about starting point and

Â I emphasize times zero.

Â Think about the end point, too.

Â And at the end point if it's ten year project,

Â you wrap things up, sell your inventory, bring it back, we'll talk about it.

Â But if you're going to expect the project to last longer than ten years,

Â you worry about something that's called terminal value.

Â What's the value of the project at the end of it?

Â We'll talk about it, promise.

Â In the context of bonds and stocks it fits very naturally.

Â Now, unequal lives.

Â So, let me give you an example and let's just, we'll then promise to stop at that.

Â And I'm going to write some numbers for you and please bear with me.

Â 9:09

And I'm going to make it very simple so that you understand.

Â Times 0, 1, 2, and 3.

Â Okay, so project A looks like this.

Â 20 million negative expense.

Â 2 million, 2 million, and I'll explain in a second.

Â And project B looks like this, 25 million, 1 million, 1 million, 1 million.

Â 9:48

One is two years long, one is three years long.

Â So what are these projects?

Â This is a classic case of creating value by making a machine choice.

Â Remember what did I say, the first thing when you start a new project,

Â you have to choose between machines.

Â 10:29

What is 1 million maintenance?

Â This is not working capital, this is maintaining the machine.

Â 1 million, 1 million, 1 million, how many eight years does this last 3 million?

Â 10:56

Answer is yes if you tell me what?

Â The discount rate or the interest rate.

Â And let's assume for the simplicity that R is 5%.

Â [COUGH] Can you do this exercise?

Â Oh yeah, I can, very simply.

Â The good news is, I just have to do a simple PV analysis.

Â Turns out if I do this, the PV of the first,

Â PVA is equal to negative 23.72.

Â 11:28

PVB is equal to negative 27.72.

Â How did I do this PV analysis?

Â Remember these are only costs, how did I do that?

Â Well, very simple.

Â For A, what did I do?

Â 20 million.

Â Do I do the present value of 20?

Â No.

Â Then I do present value of 2 million, for one year, 2 million for two years.

Â If I just add up these numbers, how much do I get?

Â 24 million.

Â Why am I getting 23.72?

Â Simply, it has to be less than 24 million, Why not by too much?

Â Because, 20 million is a chunk that's not being discounted and

Â 2 million at only 5% rate of return.

Â Remember the 5% discount rate is a low number.

Â Similarly 25 million, 1 million, 1 million,

Â 1 million, which machine will you choose?

Â 12:51

The cheaper machine is usually also a shorter-lived

Â machine, not always, but usually.

Â It not only more maintenance, it lasts less.

Â So can I compare these two?

Â Answer is no.

Â 13:19

One way to do it is what?

Â To make everything equal in life.

Â So how many machines do I buy?

Â I keep buying machines.

Â So that the lives of the two horizons are the same, right?

Â 13:46

That is how much is 23.72 per year.

Â Taking into account time value of money and

Â this works out to be 12.76.

Â So annuity PNT of A is 12.76.

Â So what is 12.76?

Â If I take 23.72 and spread it over two years, but

Â taking time value of money into count, it's 12.76 per year.

Â If I spread this over three years PNT

Â of B turns out to be 10.18.

Â What am I asking here?

Â I'm asking the following questions.

Â If I had just 23.72 for the fact that it last only two years,

Â it works out to be more costly per year.

Â If I had just 27.72 for three years, what happens?

Â The per year costs are only 10, so which one will you choose?

Â You'll choose machine B.

Â 14:58

Then I'll come back to this and I'll work through how I got these PNTs next time,

Â but right now, I challenge you to think about this problem and

Â try to do all this analysis on your own.

Â The numbers are up there for you and you have til next time and some more practice.

Â So final point today, please take the time to understand

Â what's going on in the video and then do your assessments every

Â week I force you or require you to do an assessment.

Â I can't force you, you are far away.

Â So I would really encourage you to do these problems and

Â then do assessments and try to figure this piece out on your own and

Â figure out why did I say you actually should choose machine B.

Â