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