Chapter 7

Risk analysis

Objectives:
Evaluate the risk of an investment
project
 Chapter 7
Risk analysis

 Sensitivity analysis
 Scenario analysis
 Simulation
 Break even point

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 7.1 Sensitivity analysis
Example:

Sensitivity analysis
 The change of NPV. Using What-if
analysis.
 - Average case
 - Best case
 - Worst case

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 7.1 Sensitivity analysis
Average Worst Best case
case case
Quantity (unit) 6,000 5,500 6,500

Price 80 75 85

VC per unit (USD) 60 58 62

FC per year (excluding 50,000 45,000 55,000

depreciation)
(USD)

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 7.1 Sensitivity analysis
 Basic Scenario:
 Revenue: $480,000
 Variable Costs: $360,000
 Fixed Costs: $50,000
 Depreciation: $40,000 (Note: $200,000
over 5 years)
 EBIT: $30,000
 Tax (34%): $10,200
 Net Income: $19,800

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 7.1 Sensitivity analysis

Worst-case scenario:
Price decreases, costs increase.

Best-case scenario:
Price increases, costs decrease.

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 7.1 Sensitivity analysis
Case Net NCF NPV IRR
income (12%)
Basic 19,800 59,800 15,567 15.1%

Worst -15,510 24,490 -111,719 -14.4%

Best 59,730 99,730 159,504 40.9%

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 7.1 Sensitivity analysis

 Sensitivityanalysis: Isolating one factor impacting

NPV, while keeping other factors constant, to
identify the factor with the largest influence on
NPV. Example: Varying quantity sold while
keeping other indicators unchanged.
Case Quantity NCF NPV IRR
(12%)
Basic 6000 59,800 15,567 15.1%
Worst 5500 53,200 -8,226 10.3%
Best 6500 66,400 39,357 19.7%
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 7.1 Sensitivity analysis

Example: Let FC change (Ceteris paribus).

Case FC CF NPV IRR

(12%)
Basic 50,000 59,800 15,567 15.1%
Worst 55,000 56,500 3,670 12.7%
Best 45,000 63,100 27,461 17.4%

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 7.1 Sensitivity analysis

Sensitivity analysis: Which factor has the

greatest impact on NPV?
Quantity Impact on
sold NPV

Quantity +/- 8,3% +/- 152,82%

sold
Fixed cost +/- 10% +/- 76,48%

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 7.1 Sensitivity analysis
Using Excel for Sensitivity analysis.
Using Table in Excel

Data  What if analysis Data Table

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 7.2 Scenario analysis
Scenario analysis:
- Combination of scenario analysis and sensitivity
analysis:
+ Example: Price variation in consumption scenarios for
the product: best, worst, and base -> 3 NPV values.
+ Example: Simultaneous change in price and fixed
costs in consumption scenarios for the product: best,
worst, and base -> 9 NPV values.
- Probability forecasting for the occurrence of scenarios
is necessary to calculate the expected value (the average
value of NPV).
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 7.2 Scenario analysis

 Using excel:
 Data What if analysis Scenarios manager

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 7.3 Break even point

 Example Break even point

 Application of bidding pricing?

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 7.3 Break even point
 Break even point for EBIT
FC
Q
p-v
Q : Quantity
 FC: Total fixed cost
 v: Variable cost per unit
 p: Price

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 7.3 Break even point

 Break even point: Accounting BEP

 Net income = 0

FC  I
Q
p-v
 However, there may be the case where NPV <0

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 7.3 Break even point

 Break even point: Financial BEP

 At financial BEP, NPV = 0, PP = n, IRR =

Hurdle rate

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 7.3 Break even point

 Using Excel: Break even point

 Using Goal Seek in Excel.
 Data What if analysis Goal Seek.

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 7.4 Simulation

Allows for calculating the probability of incurring

losses.

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 Summary

- There are several methods of project risk analysis.

The essence of risk analysis is to consider various
possible scenarios.
- Each method has its own advantages and
disadvantages. Analysts should use a combination of
methods to achieve a comprehensive evaluation
result.
End!

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