ch 11 (Project Analysis)

ch 11 (Project Analysis) - Key Concepts and Skills Chapter...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 11 Project Analysis and Evaluation Slide 11 - 1 Key Concepts and Skills ± Understand forecasting risk ± Understand scenario and sensitivity analyses ± Understand break-even analysis ± Understand operating leverage Slide 11 - 2 ± NPV Estimates A positive NPV is a good start. However, NPV estimates depend on projected future cash flows. If there are errors in those projections, the estimated NPVs can be misleading. ± Forecasting Risk Forecasting risk is the possibility that errors in projected cash flows will lead to incorrect decisions. How sensitive is our NPV to changes in the cash flow estimates? The more sensitive, the greater the forecasting risk. Evaluating NPV Estimates Slide 11 - 3 ± Scenario Analysis What happens to the NPV under different CF scenarios? At the very least, look at three scenarios: ¾ Best (or optimistic) case – high revenues, low costs ¾ Worst (or pessimistic) case – low revenues, high costs ¾ Base case Best case and worst case are not necessarily probable, but they can still be possible. What-If Analyses
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Slide 11 - 4 Example: a new project Consider the project discussed in the textbook: The initial cost is $200,000 and the project has a 5-year life. There is no salvage. Depreciation is straight-line, the required return is 12%, and the tax rate is 34%. The following table summarizes the results from the scenario analysis shown in the posted spreadsheet: 40.9% 159,504 99,730 59,730 Best Case -14.4% -111,719 24,490 -15,510 Worst Case 15.1% 15,567 59,800 19,800 Base case IRR NPV Cash Flow Net Income Scenario What-If Analyses Slide 11 - 5 ± Sensitivity Analysis What happens to NPV when we vary one variable at a time? This is a subset of scenario analysis where we are looking at the effect of specific variables (such as sales, costs, etc.) on a project. The greater the volatility in NPV in relation to a specific variable, the larger the forecasting risk associated with that variable, and the more attention we want to pay to its estimation. Sensitivity analysis for unit sales (above example): 19.7% 39,357 66,400 6500 Best case 10.3% -8,226 53,200 5500 Worst case 15.1% 15,567 59,800 6000 Base case IRR NPV Cash Flow Unit Sales Scenario What-If Analyses Slide 11 - 6 ± Simulation Analysis Simulation is a combination of scenario and sensitivity analyses Standard simulation method can be used to estimate numerous possible outcomes some good and some bad, but we don’t get any guidance as to what to do the output is a probability distribution for NPV with an estimate of the probability of obtaining a positive NPV. At some point you have to make a decision
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 04/18/2011 for the course FINA 1003 taught by Professor Lin during the Fall '11 term at HKU.

Page1 / 6

ch 11 (Project Analysis) - Key Concepts and Skills Chapter...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online