0:52

Why? Because you worry about them only for

tax reasons.

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

The second issue to worry about is working capital.

And remember working capital is coming from again two forms,

1:28

I apologize for that slip up.

I meant total capital broken up into two parts.

Capex and working capital come from balance sheet.

And remember, therefore you have to think about changes.

1:48

Think about accounting a lot more than this.

I have emphasized earlier, that this is the one area

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

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

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

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

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

2:27

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

Important principle, very important,

do not mix financing with operations.

And I think I tried to emphasize this earlier,

that while you are doing project analysis, stay here.

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

because these assets give you cash flows and

then we later worry about what the discount rate is.

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

this is extremely important.

3:02

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

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

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

3:19

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

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

the cash flows.

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

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

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

Every time your hand goes in this direction and

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

3:57

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

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

necessarily only conceptual argument.

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

And the reason is two.

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

Second, when you are discounting your cashflow,

you're taking financing into account.

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

4:30

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

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

only shares, all the money goes to them.

If you have debt and equity,

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

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

Okay? Very important.

5:01

In V actually have, sorry.

Model one probably include the effects of inflation/deflation.

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

What do I mean by that?

When you are doing C1, when you are doing.

5:21

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

Right?

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

It's price x quantity.

P1, P1.

Price x quantity, P2 and so on.

When you are projecting the prices please remember inflation.

5:47

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

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

Decrease over time.

So I'm not necessarily mean inflation.

I see inflation or deflation.

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

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

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

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

But inflation is always in the R.

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

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

And one last comment about inflation.

Every item in your accounting statement, or

your cash flow statement rather, has a different inflation.

So your revenues may be growing at 10%, but

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

Why? Because one is a supply and input and

the other is a demand based output.

And they're different animals.

Right?

So the inflation and everything is not constant.

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

different things.

One last comment.

It used to be a very tough thing to do.

Why?

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

But now you have prices on everything available and

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

If there's a lot of availability and

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

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

7:55

And for today before I forget to emphasize,

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

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

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

8:11

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

the ten years of the project?

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

I emphasize times zero.

Think about the end point, too.

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

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

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

you worry about something that's called terminal value.

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

We'll talk about it, promise.

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

Now, unequal lives.

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

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

9:09

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

Times 0, 1, 2, and 3.

Okay, so project A looks like this.

20 million negative expense.

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

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

9:48

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

So what are these projects?

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

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

you have to choose between machines.

10:29

What is 1 million maintenance?

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

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

10:56

Answer is yes if you tell me what?

The discount rate or the interest rate.

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

[COUGH] Can you do this exercise?

Oh yeah, I can, very simply.

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

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

PVA is equal to negative 23.72.

11:28

PVB is equal to negative 27.72.

How did I do this PV analysis?

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

Well, very simple.

For A, what did I do?

20 million.

Do I do the present value of 20?

No.

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

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

24 million.

Why am I getting 23.72?

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

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

2 million at only 5% rate of return.

Remember the 5% discount rate is a low number.

Similarly 25 million, 1 million, 1 million,

1 million, which machine will you choose?

12:51

The cheaper machine is usually also a shorter-lived

machine, not always, but usually.

It not only more maintenance, it lasts less.

So can I compare these two?

Answer is no.

13:19

One way to do it is what?

To make everything equal in life.

So how many machines do I buy?

I keep buying machines.

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

13:46

That is how much is 23.72 per year.

Taking into account time value of money and

this works out to be 12.76.

So annuity PNT of A is 12.76.

So what is 12.76?

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

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

If I spread this over three years PNT

of B turns out to be 10.18.

What am I asking here?

I'm asking the following questions.

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

it works out to be more costly per year.

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

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

You'll choose machine B.

14:58

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

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

try to do all this analysis on your own.

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

So final point today, please take the time to understand

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

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

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

So I would really encourage you to do these problems and

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

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