Corporate Finance Trainer
Class 1: Decision Rules & Investment Analysis
Week 1 Overview: Main Concepts
Key topics covered in this week's lecture on corporate finance fundamentals and investment decision rules.
🎯 Goal of Financial Management
The primary objective is to maximize shareholder wealth. Finance tools are designed to identify value-maximizing decisions, though real-world managers may pursue broader stakeholder objectives.
💰 Three Corporate Finance Decisions
Investment decisions (what assets to buy), financing decisions (how to fund investments), and cash management decisions (managing day-to-day liquidity).
⏰ Time Value of Money
Core principle: money today is worth more than money tomorrow. This underpins all valuation including NPV calculations, perpetuities, annuities, and discounting future cash flows.
📈 Net Present Value (NPV)
The gold standard decision rule. NPV measures value created above the required return. Accept if NPV > 0. Your professor says: "NPV is always your best friend."
⚠️ Internal Rate of Return (IRR)
The discount rate that makes NPV = 0. Popular but problematic: watch for scale problems, timing problems, and multiple/no IRR with non-conventional cash flows.
📊 Profitability Index (PI)
PI = NPV per resource consumed. Use this when facing resource constraints (limited capital, engineers, space). Rank projects by PI to maximize total value under constraints.
🕐 Payback Period
Time to recover initial investment. Simple but deeply flawed: ignores TVM, ignores cash flows after payback, and ignores risk. Know it exists, don't rely on it.
💻 Excel NPV Trap
Critical exam trap: Excel's NPV() function discounts from Year 1, not Year 0. Always use: =NPV(rate, C1:Cn) + C0
🗺️ The "Google Maps" Analogy
Your professor's key meta-message about finance tools:
- Finance tools show you the value-maximizing route (like GPS showing the fastest route)
- Real decision-makers might intentionally choose different objectives (sustainability, stakeholder value, etc.)
- That's a strategic choice, not a "math error" — the tools assume shareholder value maximization
- Understanding this distinction is crucial for applying theory to real-world decisions
✅ Decision Rule Hierarchy (What to Remember)
- NPV — Always reliable, shows actual value created
- PI — Use when resource-constrained (capital, people, space)
- IRR — Good for communication, but watch for pitfalls
- Payback — Know it exists, never rely on it alone
Investment Decision Calculator
IRR Pitfalls: Interactive Demonstrations
Your professor warns: "IRR is not the actual return!" — here's why.
1. Scale Problem
IRR = 100%
NPV @ 10% = $0.82
IRR = 50%
NPV @ 10% = $363.64
2. Timing Problem
IRR = 50%
IRR = 24.6%
At low discount rates (below ~11%), Project D has higher NPV despite lower IRR. Rankings can flip depending on your discount rate!
3. Multiple IRRs (Non-Conventional Cash Flows)
This pattern (- + - +) can have multiple IRRs or no real IRR
🎯 Your Professor's Bottom Line
"NPV is always your best friend."
IRR is useful for communication (managers like percentages), but for actual decision-making — especially with mutually exclusive projects,
non-conventional cash flows, or scale differences — trust NPV.
Week 1 Formula Cheat Sheet
Net Present Value (NPV)
Decision Rule: Accept if NPV > 0 (adds shareholder value)
Perpetuity Formulas
Growing Perpetuity: PV = C / (r - g) ⚠️ requires r > g
Annuity Formulas
Growing Annuity PV = C × [1 - ((1+g)/(1+r))ⁿ] / (r - g)
Profitability Index (PI)
or: PI = (NPV + Initial Investment) / Initial Investment
Use when: Resource constrained (capital, engineers, space, etc.)
Decision Rule: Accept if PI > 1; rank by PI under constraints
⚡ Excel Formulas (Watch the Trap!)
CORRECT: =NPV(rate, C1:Cn) + C0
IRR: =IRR(C0:Cn) (include all cash flows including C0)
🎯 Decision Rule Hierarchy (Professor's Priority)
- NPV — Always reliable, shows actual value created
- PI — Use when resource-constrained
- IRR — Useful for communication, but watch for pitfalls
- Payback — Know it exists, don't rely on it