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Transcript of Chapter 11 Principles PrinciplesofCorporateFinance Ninth Edition Project Analysis Slides by Matthew...
Chapter 11 PrinciplesPrinciples
ofof
CorporateCorporate
FinanceFinance
Ninth Edition
Project Analysis
Slides by
Matthew Will
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
McGraw Hill/Irwin
11- 2
Topics Covered
The Capital Investment ProcessSensitivity Analysis
– Break Even Analysis
Monte Carlo SimulationReal Options and Decision Trees
11- 3
Capital Investments
Items for consideration
Capital Budget – A list of investment projects under consideration by a firm
Do not add fudge factors to the cost of capital
Post audits – A review of the project to see how closely it met forewcasts
11- 4
How To Handle Uncertainty
Sensitivity Analysis - Analysis of the effects of changes in sales, costs, etc. on a project.
Scenario Analysis - Project analysis given a particular combination of assumptions.
Simulation Analysis - Estimation of the probabilities of different possible outcomes.
Break Even Analysis - Analysis of the level of sales (or other variable) at which the company breaks even.
11- 5
Sensitivity Analysis
ExampleGiven the expected cash flow forecasts for Otobai Company’s Motor Scooter project, listed on the next slide, determine the NPV of the project given changes in the cash flow components using a 10% cost of capital. Assume that all variables remain constant, except the one you are changing.
11- 6
Sensitivity Analysis
Example - continued
315- FlowCashNet
3.0flow cash Operating
1.5after taxProfit
1.550% @ .Taxes
3profitPretax
1.5onDepreciati
3Costs Fixed
30Costs Variable
37.5Sales
15-Investment
10-1 Years0Year
NPV= 3.43 billion Yen
11- 7
Sensitivity Analysis
Example - continued
Possible Outcomes
bil 2bil 3bil 4Cost Fixed
275,000300,000360,000CostVar Unit
380,000375,000350,000priceUnit
.16.1.04ShareMarket
mil 1.1mil 1.0mil .9SizeMarket
OptimisticExpectedcPessimistiVariable
Range
11- 8
Sensitivity Analysis
Example - continuedNPV Calculations for Optimistic Market Size Scenario
NPV= +5.7 bil yen
3.3815- FlowCashNet
3.38flow cash Operating
1.88after taxProfit
1.8850% @ .Taxes
3.75profitPretax
1.5onDepreciati
3Costs Fixed
33Costs Variable
41.25Sales
15-Investment
10-1 Years0Year
11- 9
Sensitivity Analysis
Example - continued
NPV Possibilities (Billions Yen)
6.53.40.4Cost Fixed
11.13.415.0-CostVar Unit
5.03.44.2-priceUnit
17.33.410.4-ShareMarket
5.73.41.1SizeMarket
OptimisticExpectedcPessimistiVariable
Range
11- 10
Break Even Analysis
Point at which the NPV=0 is the break even point Otobai Motors has a breakeven point of 85,000
units sold.
Sales, 000’s
PV (Yen)
Billions
400
200
19.6
85 200
Break even
NPV=0
PV Inflows
PV Outflows
11- 11
Break Even Analysis
Accounting break even is different, yet wrong. It does not consider the time value of money.
Otobai Motors has an accounting breakeven point of 60,000 units sold.
Sales, 000’s
Accounting revenue and costs (Yen)
Billions
60
40
20
60 200
Break even
Profit =0
Revenues
Costs
11- 12
Electric Scooter – NPV
Cash Flows, Years 1-10, Billions
Base CaseHigh Oil Prices and
Recession Case
1 Revenue 37.5 44.9 2 Variable cost 30.0 35.9 3 Fixed cost 3.0 3.5 4 Depreciation 1.5 1.5 5 Pretax profit (1-2-3-4) 3.0 4.0 6 Tax 1.5 2.0 7 Net profit (5-6) 1.5 2.0 8 Net cash flow (4+7) 3.0 3.5
18.4 21.5 NPV 3.4 6.5
PV of cash flows
11- 13
Electric Scooter - Assumptions
Base CaseHigh Oil Prices and
Recession CaseMarket size 1 million .8 million
Market share 0.1 0.13Unit Price 375000 431300
Unit variable cost 300000 345000Fixed cost 3 billion 3.5 billion
Assumptions
11- 14
Electric Scooter - Scenarios
InflowsYear 0
Unit Sales, Thousands
Revenue, Years 1-10 Investment
Variable Costs
Fixed Costs Taxes PV Inflows
PV Outflows NPV
0 0 15 0 3 -2.25 0 19.6 -19.6100 37.5 15 30 3 1.5 230.4 227 3.4200 75 15 60 3 5.25 460.8 434.4 26.4
OutflowsYears 1-10
11- 15
Electric Scooter – Accounting Profit
Unit Sales, Thousands Revenue
Variable Costs
Fixed Costs Depreciation Taxes
Total Costs
Profit after Tax
0 0 0 3 1.5 -2.25 2.25 -2.25100 37.5 30 3 1.5 1.5 36 1.5200 75 60 3 1.5 5.25 69.75 5.25
11- 16
Electric Scooter – Cash Flows
Year 0 Year 1-10
Investment 15.00 1. Revenue 37.50 2. Variable cost 12.00 3. Fixed cost 19.00 4. Depreciation 1.50
5. Pretax profit (1-2-3-4) 5.00 6.Tax 2.50 7. Net profit (5-6) 2.50
8. Operating cash flow (4+7) 4.00
Net cash flow (15.00) 4.00
11- 17
Monte Carlo Simulation
Step 1: Modeling the ProjectStep 2: Specifying ProbabilitiesStep 3: Simulate the Cash Flows
Modeling Process
11- 18
Monte Carlo Simulation
11- 19
Flexibility & Real Options
Decision Trees - Diagram of sequential decisions and possible outcomes.
Decision trees help companies determine their Options by showing the various choices and outcomes.
The Option to avoid a loss or produce extra profit has value.
The ability to create an Option thus has value that can be bought or sold.
11- 20
Decision Trees
NPV=0
Don’t test
Test (Invest $200,000)
Success
Failure
Pursue project NPV=$2million
Stop project
NPV=0
11- 21
Real Options
1. Option to expand
2. Option to abandon
3. Timing option
4. Flexible production facilities
11- 22
Decision Trees
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
+150(.6)
+30(.4)
+100(.6)
+50(.4)
-550
NPV= ?
-250
NPV= ?
-150
0
or
Turboprop
Piston
11- 23
Decision Trees
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
+150(.6)
+30(.4)
+100(.6)
+50(.4)
-550
NPV= ?
-250
NPV= ?
-150
0
or
812
456
660
364
148
Turboprop
Piston
11- 24
Decision Trees
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
+150(.6)
+30(.4)
+100(.6)
+50(.4)
-550
NPV= ?
-250
NPV= ?
-150
0
or
812
456
660
364
148 81220.22080.960
Turboprop
Piston
11- 25
Decision Trees
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
-550
NPV= ?
-250
NPV= ?
-150
0
or
812
456
660
364
148
+150(.6)
+30(.4)
+100(.6)
+50(.4)
*450
331
45015010.1
660 450150
10.1
660
Turboprop
Piston
11- 26
Decision Trees
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
-550
NPV= ?
-250
NPV= ?
-150
0
or
812
456
660
364
148
+150(.6)
+30(.4)
+100(.6)
+50(.4)
NPV=444.55
NPV=888.18
NPV=550.00
NPV=184.55
*450
331
18.88815010.1
812 18.888150
10.1
812
Turboprop
Piston
11- 27
Decision Trees
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
812
456
660
364
148
+150(.6)
710.73
+30(.4)
+100(.6)
403.82
+50(.4)
-150
0
*450
331
or
NPV=444.55
NPV=888.18
NPV=550.00
NPV=184.55
-550
NPV= ?
-250
NPV= ?
40.55.44460.18.888 40.55.44460.18.888
Turboprop
Piston
11- 28
Decision Trees
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
812
456
660
364
148
+150(.6)
710.73
+30(.4)
+100(.6)
403.82
+50(.4)
-550
NPV=96.12
-250
NPV=117.00
-150
0
*450
331
or
NPV=444.55
NPV=888.18
NPV=550.00
NPV=184.55
12.9655010.1
73.710 12.96550
10.1
73.710
Turboprop
Piston
11- 29
Decision Trees
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
812
456
660
364
148
+150(.6)
710.73
+30(.4)
+100(.6)
403.82
+50(.4)
-550
NPV=96.12
-250
NPV=117.00
-150
0
*450
331
or
NPV=444.55
NPV=888.18
NPV=550.00
NPV=184.55
Turboprop
Piston
11- 30
Web Resources
www.jaxworks.com
www.decisioneering.com
www.kellogg.northwestern.edu/
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