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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 Normal Worst 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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