ch%2011%20(Project%20Analysis)[1]

ch%2011%20(Project%20Analysis)[1] - 11 Project Analysis and...

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11 Project Analysis and Evaluation Slide 11 - 1 Key Concepts and Skills ± Understand forecasting risk and sources of value ± Understand scenario and sensitivity analyses ± Understand the various forms of break-even analysis ± Understand operating leverage
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Slide 11 - 2 ± NPV Estimates A positive NPV is a good start. However, NPV estimates depend on projected future cash flows. If there are errors in those projections, the estimated NPVs can be misleading. Forecasting Risk Forecasting risk is the possibility that errors in projected cash flows will lead to incorrect decisions. How sensitive is our NPV to changes in the cash flow estimates? The more sensitive, the greater the forecasting risk. Sources of Value Why does this project create value? Pay attention to the degree of competition in the market. Evaluating NPV Estimates Slide 11 - 3 ± Scenario Analysis What Happens to the NPV under Different CF Scenarios? At the very least, look at three scenarios: ¾ Best (or optimistic) case – high revenues, low costs ¾ Worst (or pessimistic) case – low revenues, high costs ¾ Base case Best case and worst case are not necessarily probable, but they can still be possible. What-If Analyses
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Slide 11 - 4 Scenario Analysis: New Project Example Consider the project discussed in the text: 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
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Slide 11 - 6 ± Simulation Analysis Simulation is a combination of the scenario and sensitivity analysis Standard simulation method can be used to estimate thousands of possible outcomes based on conditional probability distributions and constraints for each of the variables The output is a probability distribution for NPV with an estimate of the probability of obtaining a positive net present value
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ch%2011%20(Project%20Analysis)[1] - 11 Project Analysis and...

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