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chap009.ppt
1.
Chapter 9 Fundamentals of Corporate Finance Fifth
Edition Slides by Matthew Will McGraw Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Project Analysis
2.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 2 Topics Covered How Firms Organize the Investment Process Some “What If” Questions Sensitivity Analysis Scenario Analysis Break Even Analysis Real Options and the Value of Flexibility
3.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 3 Capital Budgeting Process Capital Budget - The list of planned investment projects. The Decision Process 1 - Develop and rank all investment projects 2 - Authorize projects based on: • Outlays required by law of company policy • Maintenance of cost reduction • Capacity expansion in existing business • Investment for new products
4.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 4 Capital Budgeting Process Capital Budgeting Problems Consistent forecasts Conflict of interest Forecast bias Selection criteria (NPV and others)
5.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 5 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.
6.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 6 Sensitivity Analysis Example Given the expected cash flow forecasts listed on the next slide, determine the NPV of the project given changes in the cash flow components using an 8% cost of capital. Assume that all variables remain constant, except the one you are changing.
7.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 7 Sensitivity Analysis 780 5,400 - Flow Cash Net 780 flow cash Operating 330 after tax Profit 220 40% @ .Taxes 550 profit Pretax 450 on Depreciati 2,000 Costs Fixed 13,000 Costs Variable 16,000 Sales 5,400 - Investment 12 - 1 Years 0 Year Example – continued (,000s) NPV= $478
8.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 8 Sensitivity Analysis Example - continued Possible Outcomes 1,900 2,000 2,100 ) Costs(000s Fixed 80% 81.25% 83% sales) of (% Cost Var 18,000 16,000 14,000 ) Sales(000s 5,000 5,400 6,200 (000s) Investment Optimistic Expected c Pessimisti Variable Range
9.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 9 Sensitivity Analysis Example - continued NPV Calculations for Pessimistic Investment Scenario 780 6,200 - Flow Cash Net 780 flow cash Operating 330 after tax Profit 220 40% @ .Taxes 550 profit Pretax 450 on Depreciati 2,000 Costs Fixed 13,000 Costs Variable 16,000 Sales 6,200 - Investment 12 - 1 Years 0 Year NPV= ($121)
10.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 10 Sensitivity Analysis Example - continued NPV Possibilities 930 478 26 ) Costs(000s Fixed 1,382 478 788 - sales) of (% Cost Var 2,174 478 1,218 - ) Sales(000s 778 478 121 - (000s) ) 000 ( Investment Optimistic Expected c Pessimisti Variable s NPV
11.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 11 Scenario Analysis Example - continued Cash Flows (years 1-12) 2,018,000 - 478,000 NPV 3,382,000 5,878,000 flows cash of lue Present va 448,000 780,000 7) (4 operations from flow 8.Cash 1,200 - 330,000 after tax Profit 7. 800 - 220,000 6.Taxes 2,000 - 550,000 4) - 3 - 2 - (1 profit Pretax 5. 450,000 450,000 on Depreciati 4. 2,000,000 2,000,000 costs 3.Fixed 11,152,000 13,000,000 costs Variable 2. 000 , 600 , 13 000 , 000 , 16 Sales 1. Scenario. Store Competing Case. Base
12.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 12 Break Even Analysis Example Given the forecasted data on the next slide, determine the number of planes that the company must produce in order to break even, on an NPV basis. The company’s cost of capital is 10%.
13.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 13 Break Even Analysis 12.5 - Sold) s (3.5xPlane 900 - Flow Cash Net 162.5 - Sold) s (3.5xPlane Profit Net 162.5 - Sold) s (3.5xPlane (50%) Taxes 325 - Sold) (7xPlanes Profit Pretax 150 = 900/6 on Depreciati 175 Costs Fixed Sold 8.5xPlanes Cost Var. Sold s 15.5xPlane Sales $900 Investment 6 - 1 Years 0 Year
14.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 14 Break Even Analysis Answer (Accounting) The break even point, is the # of Planes Sold where the fixed costs and depreciation = $0. planes 46.4 162.5/3.5 sold Planes 162.5) - Sold Planes x 3.5 ( 0
15.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 15 Break Even Analysis Answer (Finance) The break even point, is the # of Planes Sold that generates a NPV=$0. The present value annuity factor of a 6 year cash flow at 10% is 4.355 Thus, 12.5) - Sold Planes x 3.5 ( 5 35 . 4 900 NPV
16.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 16 Answer Solving for “Planes Sold” 12.5) - Sold Planes 5 . 3 ( 355 . 4 900 0 x 63 = Sold Planes Break Even Analysis
17.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 17 EVA & Break Even $266,553 - millions) $2.45 - sales x (.1875 x .60 7) line - 6 line ( Added Value Economic 8. $266,553 on depreciati allowed above and over capital of Cost 7. millions) $2.45 - sales x (.1875 x .60 profit accounting tax - After 6. millions) $2.45 - sales x (.1875 x .40 40%) (as Tax 5. million $2.45 - sales) x (.1875 profit Pretax 4. $450,000 on Depreciati 3. million $2 costs Fixed 2. sales of percent 81.25 costs Variable 1.
18.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 18 EVA & Break Even EVA = accounting profit – additional cost of capital = 0 ($3.5 x planes sold - $162.50) - $56.6 = 0 Planes sold = 219.1 / 3.5 = 62.6
19.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 19 Operating Leverage Operating Leverage- The degree to which costs are fixed. Degree of Operating Leverage (DOL) - Percentage change in profits given a 1 percent change in sales. sales in change % profits in change % DOL
20.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 20 Operating Leverage Example - A company has sales outcomes that range from $16mil to $19 mil, Depending on the economy. The same conditions can produce profits in the range from $550,000 to $1,112,000. What is the DOL? DOL = = 5.45 102.2 18.75
21.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 21 Flexibility & Real Options Decision Trees - Diagram of sequential decisions and possible outcomes. Decision trees help companies determine their Options by showing the various choices and outcomes. The Option to avoid a loss or produce extra profit has value. The ability to create an Option thus has value that can be bought or sold.
22.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 22 Decision Trees NPV=0 Don’t test Test (Invest $200,000) Success Failure Pursue project NPV=$2million Stop project NPV=0
23.
Copyright © 2007
by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin 9- 23 Real Options 1. Option to expand 2. Option to abandon 3. Timing option 4. Flexible production facilities
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