10 - Chapter 11: Project Analysis and Evaluation Faculty of...

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Faculty of Business and Economics University of Hong Kong Dr. T. Lin Chapter 11: Project Analysis and Evaluation 1
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Capital Budgeting 2 9 Investment Criteria 2, 10 Discounted Cash Flow 11 Sensitivity Analysis 14 Cost of Capital
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Topics Covered Scenario Analysis Sensitivity Analysis Break Even Analysis Accounting Cash Flow Financial Operating Leverage Capital Rationing 3
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An Example: Scenario Analysis The project costs 200,000, straight line depreciation to zero over 5 years with no salvage value. Tax rate is 34%. Required return is 12% Base Case Lower Bound Upper Bound Unit Sales 6,000 5,500 6,500 Price per Unit 80 75 85 Variable costs per unit 60 58 62 Fixed costs per year $50,000 $45,000 $55,000 4
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Scenario Analysis: Base Case Lower Bound Upper Bound Unit Sales 6,000 5,500 6,500 Price per Unit 80 75 85 Variable costs per unit 60 58 62 Fixed costs per year $50,000 $45,000 $55,000 Best Normal Worst Unit Sales 6,500 6,000 5,500 Price per Unit 85 80 75 Variable costs per unit 58 60 62 Fixed costs per year $45,000 $50,000 $55,000 5
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Scenario Analysis, Pro Forma I/S Best Normal Worst Unit Sales 6,500 6,000 5,500 Price per Unit 85 80 75 Variable costs per unit 58 60 62 Fixed costs per year $45,000 $50,000 $55,000 Best Sales $552,500 $480,000 $412,500 Variable Costs 377,000 360,000 341,000 Fixed Costs 45,000 50,000 55,000 Depreciation 40,000 40,000 40,000 EBIT $90,500 $30,000 -$23,500 Taxes @ 34% 30,770 10,200 -7,990 Net Income $59,730 $19,800 -$15,510 6
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Scenario Analysis, CF Best Normal Worst Net Income $59,370 $19,800 ($15,510) Depreciation 40,000 40,000 40,000 OCF 99,370 59,800 24,490 PVA, 5 years, 12% $358,207 $215,566 $88,281 PV of NCS (200,000) (200,000) (200,000) NPV $158,207 $15,566 ($111,719) IRR 41% 15% -14% Scenario analysis is useful in telling us what can happen But it does not tell us whether or not to take the project. 7
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Sensitivity Analysis Investigate what happens to NPV when only one variable is changed. Best Normal Worst Unit Sales 6,000 6,000 6,000 Price per Unit 85 80 75 Variable costs per unit 60 60 60 Fixed costs per year $50,000 $50,000 $50,000 8
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Best Normal Worst Unit Sales 6,000 6,000 6,000 Price per Unit 85 80 75 Variable costs per unit 60 60 60 Fixed costs per year $50,000 $50,000 $50,000 Sales $510,000 $480,000 $450,000 Variable Costs 360,000 360,000 360,000 Fixed Costs 50,000 50,000 50,000 Depreciation 40,000 40,000 40,000 EBIT $60,000 $30,000 $0 Taxes @ 34% 20,400 10,200 0 Net Income $39,600 $19,800 $0 OCF 79,600 59,800 40,000 PV of OCF, 5y, 12% $286,940 $215,566 $144,191 PV of NCS (200,000) (200,000) (200,000) NPV $86,940 $15,566 ($55,809) 9
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Sensitivity Analysis: Figure Sensitivity analysis is a form of scenario analysis . It is useful for pointing
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10 - Chapter 11: Project Analysis and Evaluation Faculty of...

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