Chap009(WW-FIN357)NT(1)

Chap009(WW-FIN357)NT(1) - Chapter9...

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Chapter 9 Risk Analysis, Real Options, and  Capital Budgeting  
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9-2 Chapter Outline 9.1 Decision Trees 9.2 Sensitivity, Scenario, and Simulation 9.3 Break-even analysis 9.4 Real Options
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9-3 Key Concepts and Skills Understand decision trees Understand and apply scenario and sensitivity analysis Understand break-even analyses Understand Monte Carlo simulation Understand the importance of real options in capital budgeting
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9-4 9.1 Decision Trees Graphical representation of the investment alternatives available in each period Useful when: Uncertainties surrounding an investment can be reduced by initial information‑gathering Investment decisions are sequential Probabilities can be assigned to outcomes
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9-5 Decision Tree Analysis United Robotics is considering the production of an industrial robot for the television manufacturing industry. The net investment for this project can be separated into 3 stages. Stage 1: At t = 0, conduct a $500,000 study of the potential for robots on television assembly lines. There is an 80% chance the study will indicate potential and a 20% chance it will not.
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9-6 Decision Tree Analysis Stage 2: If it appears that a sizeable market share exists, invest $1,000,000 at t = 1 to design and build a prototype robot. There is a 60% chance that the reaction will be good and a 40% chance that it will be poor. .
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9-7 Decision Tree Analysis Stage 3: If reaction to the prototype is good, build a plant at a net cost of $10,000,000. If Stage 3 is reached, the project will generate high ($10,000,000), medium ($4,000,000), or low ($-2,000,000) net cash flows over the next four years. The probabilities of the high, medium, or low cash flows are 30%, 40%, and 30%.
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9-8 United Robotics Decision Tree ($000) Stop ($1000) Stop ($10,000) ($500) $10,000 t = 0 t = 1 t = 2 t = 3-6 $4,000 $(2,000) 0.8 0.2 0.6 0.4 0.3 0.3 0.4
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9-9 NPV (1 st  Scenario in $000) NPV @ 11.5% = $15,250 Calculate NPV for each alternative Calculate joint probabilities for each alternative Calculate E(NPV) = sum of the products of joint probability and NPV for each outcome 0 1 2 3 - 6 (500)* (1000) (10,000) 10,000
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9-10 Decision Tree Analysis ($000) Joint Prob. NPV @ 11.5% Product (Prob. x NPV) 0.144 $15,250 $2,196 0.192 436 84 0.144 (14,379) (2,071) 0.320 (1,397) (447) 0.200 (500) (100) 1.000 (E)NPV = ($338)
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9-11 9.2 Sensitivity, Scenario, and Simulation
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This note was uploaded on 10/16/2011 for the course FIN 357 taught by Professor Hadaway during the Spring '06 term at University of Texas at Austin.

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Chap009(WW-FIN357)NT(1) - Chapter9...

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