641. In the most general sense, the phrase time value of money refers to the fact that a dollar in hand today is worth more than a dollar promised at some time in the future.642. The trade-off between money now and money later thus depends on, among other things, the rate you can earn by investing.643. Directors are elected at an annual shareholders’ meeting by a vote of the holders of a majority of shares who are present and entitled to vote.644. Essentially, a preemptive right means that a company that wishes to sell stock must first offer it to the existing stockholders before offering it to the general public.645. The board of directors may decide not to pay the dividends on preferred shares, and their decision may have nothing to do with the current net income of the corporation.646. When the tax rate on dividend payments was reduced, these instruments were not included, so individuals must still pay their higher income tax rate on dividend payments received from these instruments.647. Thus, when we speak of used car dealers and real estate brokers, we recognize that the used car dealer maintains an inventory, whereas the real estate broker does not.648. Given our goal of creating value for the stockholders, the capital budgeting process can be viewed as a search for investments with positive net present values.649. Now that you understand the rule, you can be on the alert for circumstances under which it might lead to problems.650. Loosely speaking, in our example, we get our money back, along with the interest we could have earned elsewhere, in four years.651. An important consequence of this approach is that we will be evaluating the proposed project purely on its own merits, in isolation from any other activities or projects.652. In accounting for erosion, it is important to recognize that any sales lost as a result of launching a new product might be lost anyway because of future competition.653. Therefore, proposals that appear to show significant value in the face of stiff competition are particularly troublesome, and the likely reaction of the competition to any innovations must be closely examined.654. If we can’t articulate some sound economic basis for thinking ahead of time that we have found something special, then the conclusion that our project has a positive NPV should be viewed with some suspicion.655. Our goal in performing such an analysis is to assess the degree of forecasting risk and to identify the most critical components of the success or failure of an investment.656. What we are saying, again loosely speaking, is that it is unlikely that the true average of the possible values is outside this range.657. Scenario analysis is thus useful in telling us what can happen and in helping us gauge the potential for disaster, but it does not tell us whether to take a project.658. Sensitivity analysis is a variation on scenario analysis that is useful in pinpointing the areas where forecasting risk is especially severe.659. The basic idea with a sensitivity analysis is to freeze all of the variables except one and then see how sensitive our estimate of NPV is to changes in that one variable.660. If our NPV estimate turns out to be very sensitive to relatively small changes in the projected value of some component of project cash flow, then the forecasting risk associated with that variable is high.
