![Explanations
• NPV is calculated by subtracting the initial investment
from the sum of yearly $30M net cash flow.
– NPV = - 150 + 30 [1 – (1.1)10 / .1] = $34.3
• Net Cash Flow is defined as net profit plus the tax
savings you get from depreciation](https://image.slidesharecdn.com/unit4riskananlysisinprojectanalysis-230321074830-41221357/85/UNIT-4-Risk-Ananlysis-in-Project-Analysis-ppt-12-320.jpg)
![Things he may
have missed
• Future uncertainty (interest rates,
future salary, etc)
• Cost of Living differences
• Type of Job [utility function = f($, enjoyment)]
• Girlfriend / Boyfriend / Family concerns
• Others?](https://image.slidesharecdn.com/unit4riskananlysisinprojectanalysis-230321074830-41221357/85/UNIT-4-Risk-Ananlysis-in-Project-Analysis-ppt-19-320.jpg)
UNIT 4 Risk Ananlysis in Project Analysis.ppt
- 1. UNIT IV : INVESTMENT CRITERIA AND RISK ANALYSIS ANUBHA SRIVASTAVA, M.Com, Ph.D., UGC NET, Certifr Mob No..-+919667251429 E-MAIL –anubhasrivastava@christuniversity.in
- 2. Points to discuss Analysis of Risk- sources, measures and perspectives on risk, Simple estimation of risk – • Sensitivity analysis • Scenario analysis, • Simulation and • Decision tree analysis
- 3. Analysis of Risk- sources, measures and perspectives on risk • Risk Meaning - Risk is the exposure a company or organization has to factor(s) that will lower its profits or lead it to fail. Anything that threatens a company's ability to achieve its financial goals is considered a risk. • Risk in capital budgeting means uncertainty in terms of cash inflows since the project life is long and it involved a huge investment.
- 4. Sources of risk • Corporate risk e.g. economic downturn, or bankruptcy • International risk (including currency risk) • Industry-specific risk eg Airlines during COVID 19 • Market risk.- SVB bankruptcy • Project-specific risk - cost scope timing
- 5. Measures of risk We calculate the Std. Dev and coefficient of variance based on the returns and probability….
- 6. Perspectives on Risk • Systematic risk –It is the risk related to the entire market or market segment. • Unsystematic risk – It is controllable risk
- 7. Four Ways to do Project Analysis • Sensitivity Analysis • Decision Trees • Simulation Method • Scenario analysis, Decision Tree
- 8. What’s the difference? Each shows a manager different aspects of the decision he/she faces: • Sensitivity Analysis shows her how much each variable affects the NPV.. • Decision Trees are visual representations of the average outcome. • Simulation is used to analyze real projects. The goal of the simulation is to show the user the different possible outcomes of his decisions, along with the probability that each outcome will occur. • Scenario Analysis is designed to derive reasoned assessments of the likelihood and impact of plausible operational losses from business and risk management experts.
- 9. Sensitivity Analysis • Set up an Excel spreadsheet that will calculate your projects NPV • Individually change your assumptions to see how the NPV changes with respect to different variables • Helps to determine how much to spend on additional information
- 10. Jalopy Motor’s Example Suppose that you forecast the following for an electric scooter project: • Market Size of .9 million (worst case)– 1.1 million (best case) customers • Market Share of between 4% (wc)and 16% (bc) after the first year • Unit price between $3,500 (wc) and $3,800 (bc) • Unit cost (variable) between $3,600 (wc) and $2,750 (bc) • Fixed costs between $40 (wc) and 20 million (bc).
- 11. Jalopy Example (cont.) Pessimistic Expected Optimistic Market Size 900,000 1,000,000 1,100,000 Market Share 4% 10% 16% Unit Price 3,500 $ 3,750 $ 3,800 $ Unit Cost (Variable) 3,600 $ 3,000 $ 2,750 $ Fixed Costs 40,000,000 $ 30,000,000 $ 20,000,000 $ Discount Rate 10% Original Investment 150,000,000 Revenue: 375,000,000 $ Variable Cost 300,000,000 $ Fixed Cost: 30,000,000 $ Depreciation 15,000,000 $ Tax: 15,000,000 $ Net Profit (Pretax Profit - Tax): 15,000,000 $ Net Cash Flow (net profit + Depcn) 30,000,000 $ 10 Year NPV $34,337,013.17 Changing each variable individually yields the following NPV: Pessimistic Expected Optimistic Market Size 11,000,000 34,337,013 57,000,000 Market Share (104,000,000) 34,337,013 173,000,000 Unit Price (42,000,000) 34,337,013 50,000,000 Unit Cost (Variable) (150,000,000) 34,337,013 111,000,000 Fixed Costs 4,000,000 34,337,013 65,000,000
- 12. Explanations • NPV is calculated by subtracting the initial investment from the sum of yearly $30M net cash flow. – NPV = - 150 + 30 [1 – (1.1)10 / .1] = $34.3 • Net Cash Flow is defined as net profit plus the tax savings you get from depreciation
- 13. Decision Tree Analysis • A Visual Representation of Choices, Consequences, Probabilities, and Opportunities. • A Way of Breaking Down Complicated Situations Down to Easier-to-Understand Scenarios. Decision Tree
- 14. Easy Example • A Decision Tree with two choices. Go to Graduate School to get my MBA. Go to Work “in the Real World”
- 15. Notation Used in Decision Trees • A box is used to show a choice that the manager has to make. • A circle is used to show that a probability outcome will occur. • Lines connect outcomes to their choice or probability outcome.
- 16. Easy Example - Revisited What are some of the costs we should take into account when deciding whether or not to go to business school? • Tuition and Fees • Rent / Food / etc. • Opportunity cost of salary • Anticipated future earnings
- 17. Simple Decision Tree Model Go to Graduate School to get my MBA. Go to Work “in the Real World” 2 Years of tuition: $55,000, 2 years of Room/Board: $20,000; 2 years of Opportunity Cost of Salary = $100,000 Total = $175,000. PLUS Anticipated 5 year salary after Business School = $600,000. NPV (business school) = $600,000 - $175,000 = $425,000 First two year salary = $100,000 (from above), minus expenses of $20,000. Final five year salary = $330,000 NPV (no b-school) = $410,000 Is this a realistic model? What is missing? Go to Business School
- 18. The Yeaple Study (1994) According to Ronald Yeaple, it is only profitable to go to one of the top 15 Business Schools – otherwise you have a NEGATIVE NPV! (Economist, Aug. 6, 1994) Benefits of Learning School Net Value ($) Harvard $148,378 Chicago $106,378 Stanford $97,462 MIT (Sloan) $85,736 Yale $83,775 Northwestern $53,526 Berkeley $54,101 Wharton $59,486 UCLA $55,088 Virginia $30,046 Cornell $30,974 Michigan $21,502 Dartmouth $22,509 Carnegie Mellon $18,679 Texas $17,459 Rochester - $307 Indiana - $3,315 North Carolina - $4,565 Duke - $17,631 NYU - $3,749
- 19. Things he may have missed • Future uncertainty (interest rates, future salary, etc) • Cost of Living differences • Type of Job [utility function = f($, enjoyment)] • Girlfriend / Boyfriend / Family concerns • Others?
- 20. Another example
- 21. Scenario analysis • The simple sensitivity analysis assumes that variables are independent of each other. In practice, the variables will be interrelated and they may change in combination. One way to examine the risk of investment is to analyse the impact of alternative combinations of variables, called scenarios, on the project’s NPV (or IRR)
- 22. Scenario analysis • Examlpe -we assume volume 1,250, selling price `18, variable cost `10.50 and fixed cost `5,500. After entering these values, you click OK; the Scenario Manager dialogue box will appear. You can click Add to enter another scenario. If you highlight scenario, Expected Scenario and click on Show, the Worksheet will change to show cash flows and NPV.
- 23. Cont..
- 24. Cont..
- 25. Simulations/ Monte Carlo Analysis The Monte Carlo simulation or simply the simulation analysis considers the interactions among variables and probabilities of the change in variables. It does not give the project’s NPV as a single number; rather it computes the probability distribution of NPV. The simulation analysis is an extension of scenario analysis. In simulation analysis a computer generates a very large number of scenarios according to the probability distributions of the variables Step 1 – Model the project (where are choices made, where are the chances) Step 2 – Assign Probabilities to outcomes (assumption) Step 3 – Simulate the Cash Flows (use a computer simulation program) The result will be a probability distribution.
- 26. Thank You