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Lecture Fundamentals of corporate finance - Chapter 11: Project analysis and evaluation

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,. | T11.1 Chapter Outline Chapter 11 Project Analysis and Evaluation Chapter Organization 11.1 Evaluating NPV Estimates 11.2 Scenario and Other “What-if” Analyses 11.3 Break-Even Analysis 11.4 Operating Cash Flow, Sales Volume, and Break-Even 11.5 Operating Leverage 11.6 Additional Considerations in Capital Budgeting 11.7 Summary and Conclusions CLICK MOUSE OR HIT SPACEBAR TO ADVANCE copyright © 2002 McGraw-Hill Ryerson, Ltd. T11.2 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 T11.3 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 T11.4 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 T11.4 Fairways Driving Range Example (concluded) Estimated annual cash inflows: $10,000 + | T11.1 Chapter Outline Chapter 11 Project Analysis and Evaluation Chapter Organization 11.1 Evaluating NPV Estimates 11.2 Scenario and Other “What-if” Analyses 11.3 Break-Even Analysis 11.4 Operating Cash Flow, Sales Volume, and Break-Even 11.5 Operating Leverage 11.6 Additional Considerations in Capital Budgeting 11.7 Summary and Conclusions CLICK MOUSE OR HIT SPACEBAR TO ADVANCE copyright © 2002 McGraw-Hill Ryerson, Ltd. T11.2 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 T11.3 Evaluating NPV Estimates II: Scenario and Other “What-If” Analyses Scenario and Other “What-If” .