Chapter

Brealey,Myers,andAllen
PrinciplesofCorporateFinance
11thEdition
PROJECTANALYSIS
10
Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
10-2
101THECAPITALINVESTMENTPROCESS
Capital Budget
List of investment projects under consideration
by a firm
Do not add fudge factors to cost of capital
Postaudit
Review of project to see if met forecasts
10-3
102SENSITIVITYANALYSIS
Types of Analysis
Sensitivity
Analyzes effects of changes in sales, costs, etc., on project
Scenario
Project analysis given particular combination of
assumptions
Simulation
Estimates probabilities of different outcomes
Break Even
Level of sales (or other variable) at which project breaks
even
10-4
102SENSITIVITYANALYSIS
Example
Given expected cash-flow forecasts for Otobai
Companys Motor Scooter project, determine
the NPV of project given changes in cash- flow
components using 10% cost of capital. Assume
constant variables, except the one you are
changing.
10-5
102SENSITIVITYANALYSIS
Example, continued
10-6
102SENSITIVITYANALYSIS
Example, continued
10-7
102SENSITIVITYANALYSIS
Example, continued
NPV calculationsOptimistic scenario
10-8
102SENSITIVITYANALYSIS
Example, continued
10-9
TABLE10.3NPVOFELECTRICSCOOTER
10-10
TABLE10.3ELECTRICSCOOTERASSUMPTIONS
10-11
TABLE10.4ELECTRICSCOOTERSCENARIOS
10-12
TABLE10.5ELECTRICSCOOTERACCOUNTING
PROFIT
10-13
TABLE10.1ELECTRICSCOOTERCASHFLOW
FORECASTS
10-14
FIGURE10.1BREAKEVENCHART
Point at which NPV=0 is break-even point
Otobai Motors has a break-even point of 85,000
units sold
Sales, thousands
PV (Yen)
Billions
400
200
19.6
85 200
Break-even
NPV = 0
PV inflows
PV
Outflows
10-15
FIGURE10.2ACCOUNTINGBREAKEVEN
Accounting break-even does not consider time
value of money
Otobai Motors has accounting break-even point
of 60,000 units sold
60 200
Sales, thousands
Accounting
revenue and
costs (Yen)
Billions
60
40
20
Break -even
Profit =0
Revenues
Costs
10-16
102SENSITIVITYANALYSIS
Operating Leverage
Degree to which costs are fixed
Degree of Operating Leverage (DOL)
Percentage change in profits given 1% change
in sales
10-17
102SENSITIVITYANALYSIS
Example
Using the data from the Otobai scooter project,
calculate the DOL
10-18
103MONTE CARLOSIMULATION
Modeling Process
Step 1: Model Project
Step 2: Specify Probabilities
Step 3: Simulate Cash Flows
Step 4: Calculate Present Value
10-19
FIGURE10.3SIMULATIONOFCASHFLOWS
10-20
104REALOPTIONSANDDECISIONTREES
Decision Trees
Diagram of sequential decisions and possible
outcomes
Help companies analyze options by showing
various choices and outcomes
Option to avoid a loss or produce extra profit
has value
Ability to create option has value that can be
bought or sold
10-21
FIGURE10.4FEDEXS EXPANSIONOPTION
10-22
FIGURE10.4FEDEXS EXPANSIONOPTION
Real Options
Option to expand
Option to abandon
Timing option
Flexible production facilities
10-23
FIGURE10.6DECISIONTREE
$700 (.80)
$ 0 (.20)
$ 300 (.80)
$ 0 (.20)
$ 100 (.80)
$ 0 (.20)
Invest
Yes / No
NPV= ?
- $18
- $130
- $130
- $130
.25
.50
.25
$ 0
.44
.56
10-24
FIGURE10.6DECISIONTREE
$700 (.80)
$ 0 (.20)
$ 300 (.80)
$ 0 (.20)
$ 100 (.80)
$ 0 (.20)
560
240
80
Invest
Yes / No
NPV= ?
- $18
- $130
- $130
- $130
.25
.50
.25
$ 0
.44
.56
10-25
FIGURE10.6DECISIONTREE
$700 (.80)
$ 0 (.20)
$ 300 (.80)
$ 0 (.20)
$ 100 (.80)
$ 0 (.20)
560
240
80
Invest
Yes / No
NPV= ?
- $18
- $130
- $130
- $130
.25
.50
.25
$ 0
.44
.56
10-26
FIGURE10.6DECISIONTREE
$700 (.80)
$ 0 (.20)
$ 300 (.80)
$ 0 (.20)
$ 100 (.80)
$ 0 (.20)
560
240
80
Invest
Yes / No
NPV= ?
- $18
- $130
- $130
- $130
.25
.50
.25
$ 0
.44
.56
NPV = $295
10-27
FIGURE10.6DECISIONTREE
$700 (.80)
$ 0 (.20)
$ 300 (.80)
$ 0 (.20)
$ 100 (.80)
$ 0 (.20)
560
240
80
Invest
Yes / No
NPV= ?
- $18
- $130
- $130
- $130
.25
.50
.25
$ 0
.44
.56
NPV = $295
NPV = $52
NPV = - $69
(do not invest, so NPV =
0)
10-28
FIGURE10.6DECISIONTREE
$700 (.80)
$ 0 (.20)
$ 300 (.80)
$ 0 (.20)
$ 100 (.80)
$ 0 (.20)
560
240
80
Invest
Yes / No
NPV= ?
- $18
- $130
- $130
- $130
.25
.50
.25
$ 0
.44
.56
NPV = $295
NPV = $52
NPV = - $69
(do not invest, so NPV =
0)
NPV = $83
10-29
FIGURE10.6DECISIONTREE
$700 (.80)
$ 0 (.20)
$ 300 (.80)
$ 0 (.20)
$ 100 (.80)
$ 0 (.20)
560
240
80
Invest
Yes / No
NPV= $19
- $18
- $130
- $130
- $130
.25
.50
.25
$ 0
.44
.56
NPV = $295
NPV = $52
NPV = - $69
(do not invest, so NPV =
0)
NPV = $83
10-30
FIGURE10.6DECISIONTREE
$700 (.80)
$ 0 (.20)
$ 300 (.80)
$ 0 (.20)
$ 100 (.80)
$ 0 (.20)
560
240
80
Invest
Yes / No
NPV= $19
- $18
- $130
- $130
- $130
.25
.50
.25
$ 0
.44
.56
NPV = $295
NPV = $52
NPV = - $69
(do not invest, so NPV =
0)
NPV = $83