Professional Documents
Culture Documents
• Learning Objectives
• Principles Used in This Chapter
1.The Importance of Risk Analysis
2.Tools for Analyzing the Risk of Project Cash Flows
3.Break-Even Analysis
4.Real Options in Capital Budgeting
• Key Terms
• Expected Values
– The expected value of a future cash flow is
given by the probability weighted average of all
the possible cash flows that might occur.
• Example 13.1
Although the project is expected to have a $209,934 NPV and a 15.59% IRR
(which exceeds the project’s 10% discount rate), it is risky, so the firm’s
analysts want to explore the importance of uncertainty in the project cash
flows. Perform a sensitivity analysis on this proposed investment.
0 $(2,300,000.00)
1 $790,000.00
2 $790,000.00
3 $790,000.00
4 $790,000.00
5 $1,590,000.00
NPV $1,001,714.68
IRR 26.65%
NPV $648,446.62
NPV $220,414.70
NPV ($259,956.99)
NPV $900,780.95
NPV $326,276.10
NPV $1,471,606.03
• Total costs
– = Variable cost (# of units) + Total fixed costs
• QBreak-even = F ÷ (P-V)
– Where F = total fixed costs
P = Sale price per unit
V = Variable cost per unit
• QBreak-even = F ÷ (P-V)
= $700,000 ÷ ($23-$21)
= $700,000 ÷ $2
= 350,000 units
P(favorable)
=.4
P(Unfavorable)
=.6
• Fixed cost
• Indirect cost
• NPV break-even analysis
• Operating leverage
• Real options
• Scenario analysis
• Sensitivity analysis
• Simulation analysis
• Value drivers
• Variable costs