Fm12 ch 13 tool kit

Download Document
Showing pages : 1 - 3 of 28
This preview has blurred sections. Sign up to view the full version! View Full Document
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 1/10/2007 Chapter 13. Tool Kit for Real Options WACC= 14% Risk-free rate = 6% Initial cost of project= $50 DCF Analysis Expected annual cash flows (in millions): Probability Cash Flow Prob. x CF 25% $33 $8.25 50% $25 $12.50 25% $5 $1.25 Expected CF = $22.00 Time Line Year 1 2 3 Expected CF ($50) $22.00 $22.00 $22.00 NPV = $1.08 Figure 13-1 DCF and Decision Tree Analysis for the Investment Timing Option (Millions of Dollars) Part 1. Scenario Analysis: Proceed with Project Today Future Cash Flows NPV of this Probability Now: Year 0 Year 1 Year 2 Year 3 Probability x NPV S $33 $33 $33 $26.61 0.25 $6.65 High-$50 Average $25 $25 $25 $8.04 0.50 $4.02 Low $5 $5 $5-$38.39 0.25-$9.60 1.00 Expected value of NPVs = $1.08 $24.02 22.32 THE INVESTMENT TIMING OPTION: AN ILLUSTRATION (Section 13.2) Murphy Systems is considering a project that will create a new type of hand-held device for connecting to the Internet. The cost of the project is $50 million, but the future cash flows are uncertain. Murphy estimates a 25% probability that the new Internet device will be very popular in which case the project will generate cash flows of $30 million each year for three years. There is a 50% probability generating cash flows of $25 million each year for three years. Unfortunately, there is a 25% chance that the Internet device will not be popular, which means that the project will generate only $5 million per year in cash flows. The cost of capital for this project is 14%. Scenario c Standard Deviation a = Coefficient of Variation b = 0.25 0.25 0.50 Part 2. Decision Tree Analysis: Implement in One Year Only if Optimal Future Cash Flows NPV of this Probability Now: Year 0 Year 1 Year 2 Year 3 Year 4 Probability x NPV S-$50 $33 $33 $33 $23.35 0.25 $5.84 High Wait Average-$50 $25 $25 $25 $7.05 0.50 $3.53 Low $0 $0 $0 $0 $0.00 0.25 $0.00 1.00 Expected value of NPVs = $9.36 $8.57 0.92 Notes: Figure 13-2 Sensitivity Analysis for the Investment Timing Option Decision Tree (Millions of Dollars) Future Cash Flows NPV of this Probability Now: Year 0 Year 1 Year 2 Year 3 Year 4 Probability x NPV S-$50 $33 $33 $33 $20.04 0.25 $5.01 High Average-$50 $25 $25 $25 $3.74 0.50 $1.87 Low $0 $0 $0 $0 $0.00 0.25 $0.00 1.00 Expected value of NPVs = $6.88 $7.75 1.13 Part 2. Sensitivity Analysis of NPV to Changes in the Cost of Capital Used to Discount Cost and Cash Flows Cost of Capital Used to Discount the Year 1 Cost $6.88 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 8.0% $13.11 $13.46 $13.80 $14.14 $14.47 $14.79 $15.11 9.0% $11.78 $12.13 $12.47 $12.81 $13.14 $13.47 $13.78 10.0% $10.50 $10.85 $11.20 $11.53 $11.86 $12.19 $12.51 11.0% $9.27 $9.62 $9.97 $10.30 $10.64 $10.96 $11.28 12.0% $8.09 $8.44 $8.78 $9.12 $9.45 $9.78 $10.09 13.0% $6.95 $7.30 $7.64 $7.98 $8.31 $8.64 $8.95 14.0% $5.85 $6.20 $6.54 $6.88 $7.21 $7.54 $7.85 15.0% $4.79 $5.14 $5.48 $5.82 $6.15 $6.48 $6.79 16.0% $3.77 $4.12 $4.46 $4.80 $5.13 $5.45 $5.77 17.0% $2.78 $3.13 $3.47 $3.81 $4.14 $4.46 $4.78 18.0% $1.83 $2.18 $2.52 $2.86 $3.19 $3.51$3....
View Full Document