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:
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What happens to NPV when we vary
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):
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Simulation is a combination of scenario and sensitivity analyses
Standard simulation method can be used to estimate numerous
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