Fundamentals of Corporate Finance Third edition Chapter 8 Project Brealey Myers Marcus Analysis ndamentals of Corporate Finan Brealey Myers Marcus slides by Matthew will IrwinMcGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 1 Irwin/McGraw-Hill Chapter 8 Fundamentals of Corporate Finance Third Edition Project Analysis Brealey Myers Marcus slides by Matthew Will Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc.,2001
8-2 Topics Covered SHow Firms Organize Their Investment Process OSome"What If Questions Sensitivity Analysis → Break Even analysis FLexibility in Capital Budgeting → Decision trees → Options Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 2 Irwin/McGraw-Hill Topics Covered How Firms Organize Their Investment Process Some “What If” Questions ➔Sensitivity Analysis ➔Break Even Analysis Flexibility in Capital Budgeting ➔Decision Trees ➔Options
8-3 Capital Budgeting Process Capital budget- The list of planned Investment projects The Decision process 1- Develop and rank all investment projects 2- Authorize projects based on Govt regulation Production efficiency Capacity requirements NPV Irwin/McGraw-Hill CThe McGraw-Hill Companies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 3 Irwin/McGraw-Hill Capital Budgeting Process Capital Budget - The list of planned investment projects. The Decision Process 1 - Develop and rank all investment projects 2 - Authorize projects based on: • Govt regulation • Production efficiency • Capacity requirements • NPV
8-4 Capital Budgeting Process CApital budgeting problems Consistent forecasts → Conflict of interest → Forecast bias )Selection criteria(NPV and others) Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 4 Irwin/McGraw-Hill Capital Budgeting Process Capital Budgeting Problems ➔Consistent forecasts ➔Conflict of interest ➔Forecast bias ➔Selection criteria (NPV and others)
8-5 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 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 5 Irwin/McGraw-Hill 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
8-6 Sensitivity analysis Example Given the expected cash flow forecasts listed on the next slide. determine the npv of the project given changes in the cash flow components using an 80 o cost of capital Assume that all variables remain constant, except the one you are changing Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 6 Irwin/McGraw-Hill Sensitivity Analysis Example Given the expected cash flow forecasts 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
8-7 Sensitivity analysis Example - continued Year 0 Years 1-12 工 nvestment 5,400 sales 16,000 Variable costs 13,000 Fixed costs 2,000 Depreciation 450 Pretax profit 550 Taxes 400 220 Profit after tax 330 Operating cash flow 780 Net cash Flow 5,400 780 NPV=$478 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 7 Irwin/McGraw-Hill Sensitivity Analysis 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 Example - continued NPV= $478
8-8 Sensitivity analysis Example -continued Possible outcomes Range Variable pessimistic Expected Optimistic Investment(000s) 6,200 5,400 5,000 Sales (000s) 14,00016,000 18,000 Var cost(号ofsa1es) 83号 81.25号 80号 Fixed Costs(000s) 2,100 2,000 1,900 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 8 Irwin/McGraw-Hill 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
8-9 Sensitivity analysis xample-continued NPy 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 400 220 Profit after taⅹ 330 Operating cash flow 780 Net cash Flow 6,200 780 NP=(S121) Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 9 Irwin/McGraw-Hill 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)
8-10 Sensitivity analysis Example -continued NPV Possibilities NPV (000s Variable pessimistic Expected Optimistic Investment(000s) 121 478 778 Sales (000s) 1,218 478 2,174 Var cost of sales) 788 478 382 Fixed Costs(000s) 26 478 930 Irwin/McGraw-Hill CThe McGraw-Hill Commpanies, Inc, 2001
©The McGraw-Hill Companies, Inc.,2001 8- 10 Irwin/McGraw-Hill Sensitivity Analysis Example - continued NPV Possibilities NPV s Variable Pessimistic Expected Optimistic Investment (000 ) (000s) - 121 478 778 Sales(000s) - 1,218 478 2,174 Var Cost (% of sales) - 788 478 1,382 Fixed Costs(000s) 26 478 930
