In chapter 11, we focus on assessing the reliability of such an estimate and on some additional considerations in project analysis. After studying this chapter, you should understand: How to perform and interpret a sensitivity analysis for a proposed investment, how to perform and interpret a scenario analysis for a proposed investment, how the degree of operating leverage can affect the cash fl ows of a project,. | Chapter Outline Chapter 11 Project Analysis and Evaluation Chapter Organization Evaluating NPV Estimates Scenario and Other “What-if” Analyses Break-Even Analysis Operating Cash Flow, Sales Volume, and Break-Even Operating Leverage Additional Considerations in Capital Budgeting Summary and Conclusions CLICK MOUSE OR HIT SPACEBAR TO ADVANCE copyright © 2002 McGraw-Hill Ryerson, Ltd. Evaluating NPV Estimates I: The Basic Problem The basic problem: How reliable is our NPV estimate? Projected vs. Actual cash flows Estimated cash flows are based on a distribution of possible outcomes each period Forecasting risk The possibility of a bad decision due to errors in cash flow projections - the GIGO phenomenon Sources of value What conditions must exist to create the estimated NPV? “What If” analysis A. Scenario analysis B. Sensitivity analysis Evaluating NPV Estimates II: Scenario and Other “What-If” Analyses Scenario and Other “What-If” Analyses “Base case” estimation Estimated NPV based on initial cash flow projections Scenario analysis Posit best- and worst-case scenarios and calculate NPVs Sensitivity analysis How does the estimated NPV change when one of the input variables changes? Simulation analysis Vary several input variables simultaneously, then construct a distribution of possible NPV estimates Fairways Driving Range Example Fairways Driving Range expects rentals to be 20,000 buckets at $3 per bucket. Equipment costs $20,000 and will be depreciated using SL over 5 years and have a $0 salvage value. Variable costs are 10% of rentals and fixed costs are $40,000 per year. Assume no increase in working capital nor any additional capital outlays. The required return is 15% and the tax rate is 15%. Revenues $60,000 Variable costs 6,000 Fixed costs 40,000 Depreciation 4,000 EBIT $10,000 Taxes (@15%) 1500 Net income $ 8,500 Fairways Driving Range Example (concluded) Estimated annual cash inflows: $10,000 + | Chapter Outline Chapter 11 Project Analysis and Evaluation Chapter Organization Evaluating NPV Estimates Scenario and Other “What-if” Analyses Break-Even Analysis Operating Cash Flow, Sales Volume, and Break-Even Operating Leverage Additional Considerations in Capital Budgeting Summary and Conclusions CLICK MOUSE OR HIT SPACEBAR TO ADVANCE copyright © 2002 McGraw-Hill Ryerson, Ltd. Evaluating NPV Estimates I: The Basic Problem The basic problem: How reliable is our NPV estimate? Projected vs. Actual cash flows Estimated cash flows are based on a distribution of possible outcomes each period Forecasting risk The possibility of a bad decision due to errors in cash flow projections - the GIGO phenomenon Sources of value What conditions must exist to create the estimated NPV? “What If” analysis A. Scenario analysis B. Sensitivity analysis Evaluating NPV Estimates II: Scenario and Other “What-If” Analyses Scenario and Other “What-If” .
