Intro to Competitive Markets

• The Fundamental Principle: In perfectly competitive markets, no firm realises economic profits e.g. pets.com downfall where the nature of the business is easily copied – the competitive aspect.
• Economic profits are returns in excess of the opportunity cost of capital. (Above and beyond accounting profits).
• In the real world, product markets are rarely perfect and firms often have competitive advantage.
• In general, firms may capture economic profits when there are either barriers to competition or barriers to imitation.

When you are presented with a project that appears to have a positive NPV, don’t just accept the calculations at face value. They may reflect simple estimation errors in forecasting cash flows. Probe behind the cash estimates and try to identify the source of economic rents. A positive NPV for a new project is believable only if you believe that the company has some special advantage.

From the chapter, “Where Positive Net Value Comes From” Brealey & Myers, Principles of Corporate Finance