Question

MM Inc. is an all-equity firm (the firm value equals the value of equity). As the CEO of MM Inc., you are considering purchasing a private jet for the firm. The private jet costs $12 million today and will save $2 million (in today’s value) on travel expenses for the firm over its life. You own 1% of MM's equity ownership. The private benefits of the private jet to you are estimated to be $800,000 in today’s value.

Suppose you a self-interested CEO. From your own perspective, what is the NPV of purchasing a private jet?

Answer 1

Net Present Value is the Present value of all the cash inflows minus the capital outlay / initial Investment. It is used while taking a capital budgeting decisions i.e. while investing in a project or making an investment.

Here, MM Inc. is considering the purchase of private jet for the firm. So, initial investment is $12 million. and it will save $2 million on travel expenses and its private benefits include $ 800,000 to the CEO.

Now, if we are calculating the NPV from CEO's Perspective then,

Initial Investment = $12 million x 1% = $ 120,000 { from CEO's perspective as his interest is 1%)

Cash Benefits in today's value ( no need to covert to it to present value) =

Travel expenses :- $ 2 million x 1% = $20,000 { from CEO's perspective as his interest is 1%)

Private Expenses :- $ 800,000 { As this entire amount is his benefit }

So, total cash benefits = $ 20,000 + $ 800,000 = $ 820,000

So, NPV from CEO's perspective = Present Value of Cash Inflows - Initial investment

= $820,000 - $120,000

= $700,000

So, purchase of Private jet by the firm will benefit the CEO. hence, it should be accepted.