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FM Ch09-Sensivity Analysis
FM Ch09-Sensivity Analysis
Project Analysis
9- 2
Topics Covered
Sensitivity Analysis
Example
Given the expected cash flow
forecasts for future 12 years
listed on the next slide,
determine the NPV of the
project given changes in the
cash flow components using an
8% cost of capital. Assume that
all variables remain constant,
except the one you are
changing.
9- 8
Sensitivity Analysis
Example continued (,000s)
Year 0 Years 1 - 12
Investment - 5,400
Sales 16,000
Variable Costs 13,000
Fixed Costs 2,000
Depreciation 450
Pretax profit 550
.Taxes @ 40% 220
Profit after tax 330
Operating cash flow 780
Net Cash Flow - 5,400 780
NPV= $478
9- 9
Sensitivity Analysis
Example - continued
Possible Outcomes
Range
Variable Pessimistic Expected Optimistic
Investment (000s) 6,200 5,400 5,000
Sales (000s) 14,000 16,000 18,000
Var Cost (% of sales) 83% 81.25% 80%
Fixed Costs (000s) 2,100 2,000 1,900
9- 10
Sensitivity Analysis
Example - continued
NPV Calculations for Pessimistic Investment Scenario
Year 0 Years 1 - 12
Investment - 6,200
Sales 16,000
Variable Costs 13,000
Fixed Costs 2,000
Depreciation 450
Pretax profit 550
.Taxes @ 40% 220
Profit after tax 330
Operating cash flow 780
Net Cash Flow - 6,200 780
NPV= ($121)
9- 11
Sensitivity Analysis
Example - continued
Sensitivity Analysis
Information retrieved
Estimationof sales seems to have a great impact
on NVP, and therefore additional survey data
may be needed
Changes of fixed costs seems less important
Scenario Analysis
Example - continued
Cash Flows (years 1-12)
Base Case. Competing Store Scenario.
1. Sales 16,000,000 13,600,000
2. Variable costs 13,000,000 11,152,000
3.Fixed costs 2,000,000 2,000,000
4. Depreciation 450,000 450,000
5. Pretax profit (1 - 2 - 3 - 4) 550,000 - 2,000
6.Taxes 220,000 - 800
7. Profit after tax 330,000 - 1,200
8.Cash flow from operations (4 + 7) 780,000 448,000
Present value of cash flows 5,878,000 3,382,000
NPV 478,000 - 2,018,000
9- 14
Simulation Analysis
Simulation analysis is an extension of scenario
analysis
Instead of arbitrarily specifying a relatively
small number of scenarios, a computer generates
several thousand possible combinations of
variables via probability distributions according
to the historical data
The entire probability distribution of outcomes
can be constructed from the simulation results
9- 15
Thus,
NPV = 900 + 4.35 5 ( 3.5 x Planes Sold - 12.5)
9- 19
Answer
Solving for Planes Sold
Planes Sold = 63
9- 20
Another example
1. Variable costs 81.25 percent of sales
2. Fixed costs $2 million
3. Depreciati on $450,000
4. Pretax profit (.1875 x sales) - $2.45 million
5. Tax (as 40%) .40 x (.1875 x sales - $2.45 millions)
6. After - tax accounting profit .60 x (.1875 x sales - $2.45 millions)
7. Cost of capital over and above allowed depreciati on $266,553
8. Economic Value Added ( = line 6 - line 7) .60 x (.1875 x sales - $2.45 millions) - $266,553
Operating Leverage
Operating Leverage - The degree to which
costs are fixed. (fixed costs)
Degree of Operating Leverage (DOL) -
Percentage change in profits given a 1
percent change in sales.
Operating Leverage
Example - A company has sales outcomes that range from
$16mil to $19 mil, depending on the economy. The same
conditions can produce profits in the range from $550,000 to
$1,112,000. What is the DOL?
102.2
DOL = 18.75 = 5.45
What is the DOL if the profits are from $550,000 to
$1,030,000?
87.3
DOL = 18.75 = 4.65
(compare the results in p.252 table 9-6)
9- 24
Operating Leverage
Decision Trees
Success
Test (Invest Pursue project
$200,000) NPV=$2million
Failure
Stop project
Dont test NPV=0
NPV=0
Each square represents an action or decision by the company
Each circle represents an outcome revealed by fate
9- 28
Real Options
Real Options Rights to invest, modify,
or dispose of a capital investment project
1. Option to expand
2. Option to abandon
3. Timing option (invest now or invest latter)
4. Flexible production facilities
(dual-fired boilers)