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Cash Flow Estimation and Risk Analysis
Cash Flow Estimation and Risk Analysis
Cash Flow Estimation and Risk Analysis
Importance in Project
Valuation
Relevance of CF over
Acctg Income
Incremental CF Basis
Business Application
Determine Value :
Based on accurate CF
Projections
New vs. Replacement
Projects
Relevant CFs
Depreciation & Tax
Effects
Inflation & Risk
Business Application
Techniques to Manage
CFs
Sensitivity Analysis
Scenario Analysis
Decision Tree Analysis
MonteCarlo Simulation
Topics
Risk analysis:
Real options
4
CF
NPV =
(1 1+ r )1
Initial cost
Market
interest rates
Market
risk aversion
CF
+
(1 2+ r)2
CF
+ + N
(1 + r)N
Projects risk-adjusted
Projects risk-adjusted
cost of capital
cost of capital
(r)
(r)
Projects
debt/equity capacity
Projects
Projects
business
business risk
risk
TYPES OF PROJECTS
Expansion
Increase in Op CFs
Replacement
Swap out equipment
Decrease in Operating
Costs
Type of Costs
Sunk Costs
Incremental Costs
Externalities
Opportunity Costs
Shipping and installation
Financing Costs
Taxes
10
Sunk Costs
11
Incremental Costs
Externalities
Treatment of Financing
Costs
NO.
Continued
15
Project Data
(Continued)
NWCt = 12%(Salest+1)
What is an assets
depreciable basis?
Basis = Cost
+ Shipping
+ Installation
$240,000
17
Annual Depreciation
Expense (000s)
Year
(Initial
Basis)
$240
=
Deprec.
$79.2
0.33
0.45
108.0
0.15
36.0
0.07
16.8
18
Year 1
Year 2
Year 3
Year 4
1,250
1,250
1,250
1,250
$200
$100
$250,00
0
$125,00
0
19
Inflation
(Continued)
21
Year 2
Sales
$250,000
$257,500
Costs
125,000
128,750
79,200
108,000
$ 45,800
$ 20,750
18,320
8,300
$ 27,480
$ 12,450
79,200
108,000
$106,680
$120,450
Deprec.
EBIT
Taxes (40%)
EBIT(1 T)
+ Deprec.
Net Op. CF
22
Year 4
Sales
$265,225
$273,188
Costs
132,613
136,588
36,000
16,800
$ 96,612
$119,800
38,645
47,920
$ 57,967
$ 71,880
36,000
16,800
$ 93,967
$ 88,680
Deprec.
EBIT
Taxes (40%)
EBIT(1 T)
+ Deprec.
Net Op. CF
23
Sales
Year
Year
Year
Year
Year
0
1 $250,000
2 257,500
3 265,225
4 273,188
CF Due to
NWC
Investment
(% of sales)
in NWC
$30,000
30,900
31,827
32,783
0
-$30,000
-900
-927
-956
32,783
24
$25
0
$25
10
$15
25
Cash flow
from sale
Sale
proceed
s
Taxe
s
paid
26
Year 0
Year 1
Year 2
0
0
$240,000
0 $106,680 $120,450
-$30,000
-$900
-$927
0
- $105,780 $119,523
29
$270,000
Year 3
Year 4
$93,967
$88,680
-$956
$32,783
$15,000
$93,011
$136,463
30
(270,000)105,780 119,523
93,011
136,463
10%
(270,000)105,780 119,523
3
93,011
4
136,463
102,312
144,623
140,793
(270,000)
MIRR = ?
524,191
32
Calculator Solution
MIRR = 18.0%.
33
(270)
106
120
93
136
(44)
49
185
Cumulative:
(270)
(164)
35
36
Stand-alone risk
Corporate risk
Market (or beta) risk
37
Stand-Alone Risk
Probability Density
Flatter distribution,
larger , larger
stand-alone risk.
E(NPV)
NPV
39
Corporate Risk
Project X is negatively
correlated to firms other assets,
so has big diversification
benefits
Profitability
If r = 1.0, no diversification
benefits. If r < 1.0, some
diversification benefits.
Project X
Total Firm
Rest of Firm
Years
41
Market Risk
What is sensitivity
analysis?
Sensitivity Analysis
Change From
Base level
-30%
-15%
0%
15%
30%
r
$113
$100
$88
$76
$65
Resulting NPV
(000s)
Unit Salvage
sales
$17
$85
$52
$86
$88
$88
$124
$90
$159
$91
46
Sensitivity Graph
NPV
($ 000s)
Unit Sales
Salvage
88
r
-30
(%)
-20
-10 Base 10
20
30
47
Results of Sensitivity
Analysis
48
50
51
0.25
$279
0.50
88
0.25
-49
E(NPV) = $101.6
(NPV) = 116.6
CV(NPV) = (NPV)/E(NPV) =
1.15
52
What is a simulation
analysis?
Simulation Example
Assumptions
Mean = 1,250
Mean = $200
56
Simulation Process
Price
NPV
1,252
$200
$88,808
199
30
$82,519
Maximum
1,927
294
$475,145
Minimum
454
Mean
Std deviation
Median
Prob NPV > 0
CV
685
94 -$166,208
$163
$84,551
86.9%
0.93
58
Histogram of Results
60
61
(More...)
62
65
New products
68
Abandonment options
Contraction
Temporary suspension
Flexibility options
69