Class 10&11&12&13 - Part 3

Class 10&11&12&13 - Part 3 -...

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Capital Budgeting Project Analysis and Evaluation
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Is a positive NPV the happy  ending? Ø No – it is rather a happy start! Ø NPV estimates are nothing but estimates Ø A closer look at the estimation is definitely  needed to minimize forecasting risk § Forecasting risk – how sensitive is the project’s  NPV to changes in the cash flow estimates?  The more sensitive it is, the greater the  forecasting risk…
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Scenario Analysis Ø What happens to the NPV under different  cash flow scenarios? Ø At the very least, look at: § Best case – high revenues, low costs § Worst case – low revenues, high costs Ø Best case and worst case are not  necessarily probable, but they can still be  possible and they clearly give an idea  about the upper and lower bounds for the  project results
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Scenario Analysis – Example  Scenario Net Income Cash Flow NPV IRR Base case 19,800 59,800 15,567 15.1% Worst Case -15,510 24,490 -111,719 -14.4% Best Case 59,730 99,730 159,504 40.9%
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Sensitivity Analysis Ø What happens to NPV when we change one  variable at a time? Ø How sensitive is our NPV estimate to  changes in specific variables?
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