Principles of

Corporate Chapter 10
Finance
A Project Is Not a Black Box
Seventh Edition
Richard A. Brealey
Stewart C. Myers

Slides by
Matthew Will

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10- 2

Topics Covered
Š Sensitivity Analysis
Š Break Even Analysis
Š Monte Carlo Simulation
Š Decision Trees

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10- 3

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.
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10- 4

Sensitivity Analysis
Example
Given the expected cash flow
forecasts for Otobai Company’s
Motor Scooter project, listed on
the next slide, determine the
NPV of the project given
changes in the cash flow
components using a 10% cost of
capital. Assume that all
variables remain constant, except
the one you are changing.

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10- 5

Sensitivity Analysis
Example - continued
Year 0 Years 1 - 10
Investment - 15
Sales 37.5
Variable Costs 30
Fixed Costs 3
Depreciati on 1.5
Pretax profit 3
.Taxes @ 50% 1.5
Profit after tax 1.5
Operating cash flow 3.0
Net Cash Flow - 15 3
NPV= 3.43 billion Yen
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10- 6

Sensitivity Analysis
Example - continued

Possible Outcomes

Range
Variable Pessimistic Expected Optimistic
Market Size .9 mil 1 mil 1.1 mil
Market Share .04 .1 .16
Unit price 350,000 375,000 380,000
Unit Var Cost 360,000 300,000 275,000
Fixed Cost 4 bil 3 bil 2 bil

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10- 7

Sensitivity Analysis
Example - continued
NPV Calculations for Optimistic Market Size Scenario
Year 0 Years 1 - 10
Investment - 15
Sales 41.25
Variable Costs 33
Fixed Costs 3
Depreciation 1.5
Pretax profit 3.75
.Taxes @ 50% 1.88
Profit after tax 1.88
NPV= +5.7 bil yen
Operating cash flow 3.38
Net Cash Flow - 15 + 3.38

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10- 8

Sensitivity Analysis
Example - continued

NPV Possibilities (Billions Yen)

Range
Variable Pessimistic Expected Optimistic
Market Size 1.1 3.4 5.7
Market Share - 10.4 3.4 17.3
Unit price - 4.2 3.4 5.0
Unit Var Cost - 15.0 3.4 11.1
Fixed Cost 0.4 3.4 6.5

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10- 9

Break Even Analysis

Š Point at which the NPV=0 is the break even point

Š Otobai Motors has a breakeven point of 85,000 units
sold.
PV Inflows

Break even
400 NPV=0
PV (Yen)
200 PV Outflows
Billions

19.6
Sales, 000’s
85 200
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10- 10

Monte Carlo Simulation

Modeling Process
Š Step 1: Modeling the Project
Š Step 2: Specifying Probabilities
Š Step 3: Simulate the Cash Flows
Š Step 4: Calculate Present Value

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10- 11

Realoptionen
Option auf Erweiterungs- oder Nachfolgeinvestition

Option, Projekt zu modifizieren

Option, Projektbeginn zu verschieben

Option auf Projektabbruch

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10- 12

Decision Trees
960 (.8)
+150(.6)
220(.2)
-550 930(.4)
NPV= ? +30(.4)
140(.6)
Turboprop
800(.8)
-150
100(.2)
+100(.6) or
410(.8)
0
180(.2)
-250
220(.4)
NPV= ? +50(.4)
100(.6)
Piston
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10- 13

Decision Trees
PV=888.18 960 (.8)
+150(.6) 812
Turboprop 220(.2)
-550 710.73 930(.4)
+30(.4) 456
NPV=96.12 140(.6)
PV=444.55
*450 800(.8)
-150 660
PV=550.00 100(.2)
+100(.6) or
410(.8)
Piston 0 364
403.82 180(.2)
331
-250
220(.4)
NPV=117.00 +50(.4) 148
PV=184.55 100(.6)

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10- 14

Aufgabe in der Vorlesung

PQ12: Neue Flugzeugpreise in t=0;
Zinssatz 8%. Welche Maschine kaufen?
960 (.8)
+150(.6)
220(.2)
-350 930(.4)
NPV= ? +30(.4)
140(.6)
Turboprop
800(.8)
-150
100(.2)
+100(.6) or
410(.8)
0
180(.2)
-180
220(.4)
NPV= ? +50(.4)
100(.6)
Piston
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10- 15

Aufgaben zu Hause
Q1, 3, 6, 8 (alle ohne Besprechung)
PQ2, 10, 13

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 Lösungshilfe Kapitel 10, PQ 13

Hi demand (.8)
Continue $960

Hi demand (.6) Lo demand (.2)

$150 $220
Quit
$500

Hi demand (.4)
Continue $930

Lo demand (.4) Lo demand (.6)

Turbo $30 $140
-$350 Quit
$500 Hi demand (.8)
Expand $800
-$150 Lo demand (.2)
Piston $100
-$180 Hi demand (.8)
Hi demand (.6) Continue $410
$100 Lo demand (.2)
Quit $150 $180

Hi demand (.4)
Continue $220

Lo demand (.4) Lo demand (.6)

$50 $100
Quit $150