10/19/2010

Section 11.5 Sensitivity Analysis

Tab 2 extends the basic model (shown in Tab 1) to include sensitivity analysis. Tab 2 also illustrates special cases of sensitivity analysis, incuding breakeven analysis, one-way data tables with multiple outputs, and two-way data tables. We also include a brief tutorial for Data Tables.

For ease of reference, we repeat Figure 11-1, Analysis of an Expansion Project: Inputs and Key Results (Dollars in Thousands) Part 1. Inputs and Key Results Inputs
Equipment cost Salvage value, equipment, Year 4 Opportunity cost Externalities (cannibalization) Units sold, Year 1 Annual change in units sold, after Year 1 Sales price per unit, Year 1 Annual change in sales price, after Year 1 Variable cost per unit (VC), Year 1 Annual change in VC, after Year 1 Nonvariable cost (Non-VC), Year 1 Annual change in Non-VC, after Year 1 Project WACC Tax rate Working capital as % of next year's sales

Base-Case
$3,400 $300 $0 $0 683 4.00% $11.73 2.00% $6.00 2.00% $2,000 2.00% 10.00% 40.00% 12.65%

Key Results
NPV IRR MIRR PI Payback Discounted payback $1,695 24.97% 19.31% 1.38 2.69 3.18

If you change any of the blue values above, the model below will change instantly, causing changes in NPV and other output variables. You can see the effect in the Key Results box shown above. If you change an input value but later want to return to the base case, use Scenario Manager to select the Base-Case. In Excel 2003, select Tools, Scenarios. In Excel 2007, select Data, What-If-Analysis, Scenario Manager.

For ease of reference, we repeat Figure 11-2. Analysis of a New (Expansion) Project: Cash Flows and Performance Measures (Dollars in Thousands)

Part 2. Cash Flows and Performance Measures

Variables Used in the Cash Flow Forecast Unit sales Sales price per unit Variable cost per unit Nonvariable costs (excluding depreciation) 0 1 683 $11.73 $6.00 $2,000 2 710 $11.97 $6.12 $2,040 3 739 $12.21 $6.24 $2,081 4 768 $12.45 $6.37 $2,122

Investment Outlays at Time = 0

Equipment Initial investment in working capital Opportunity cost, after taxes

0 -$3,400 -1,014 0

Cash Flows At End of Year 1 2 3

Net Cash Flows Over the Project's Life

Sales revenues = Units Price/unit Variable costs = Units Cost/unit Nonvariable costs (excluding depreciation) Depreciation: Accelerated, from table below Operating profit (EBIT) Taxes on operating profit Net operating profit after taxes Add back depreciation Opportunity cost, after taxes Cannibalization or complementary effects, after taxes Salvage value (taxed as ordinary income) Tax on salvage value (SV is taxed at 40%) Change in WC: Outflow () or recovery (+) $8,015 4,099 2,000 1,122 $795 318 $477 1,122 0 0 $8,503 4,348 2,040 1,530 $585 234 $351 1,530 0 0 $9,020 4,612 2,081 510 $1,817 727 $1,090 510 0 0 $9,568 4,893 2,122 238 $2,315 926 $1,389 238 0 0 300 -120 1,210

-62

-65

-69

Project net cash flows: Time Line

Project Evaluation
Results

-$4,414

$1,537

$1,816

$1,531

$3,017

NPV IRR MIRR Profitability index Payback Discounted payback

Calculations for Payback

$1,695 24.97% 19.31% 1.38 2.69 3.18 2 -$1,061 $1,501 -$1,516 45% $1,530 3 $470 $1,150 -$366 15% $510 4 $3,487 $2,061 $1,695 7% $238

Year: 0 1 Cumulative cash flows for payback -$4,414 -$2,877 Discounted cash flows for disc. payback -$4,414 $1,398 Cumulative discounted cash flows -$4,414 -$3,016 Accelerated Depreciation Depreciable basis: $3,400 Rate/year 33% Dollars/year $1,122

SENSITIVITY ANALYSIS (Section 11.5)

Risk in capital budgeting really means the probability that the actual outcome will be worse than the expected outcome. For example, if there were a high probability that the expected NPV as calculated above will actually turn out to be negative, then the project would be classified as relatively risky. The reason for a worse-than-expected outcome is, typically, because sales were lower than expected, costs were higher than expected, or the project turned out to have a higher than expected initial cost. In other words, if the assumed inputs turn out to be worse than expected, then the output will likewise be worse than expected. We use data tables below to examine the project's sensitivity to changes in the input variables.

Following is a tutorial for constructing a Data Table to be used in sensitivity analysis. This section may be skipped if you already know how to construct data tables. Instructions for Constructing Data Tables: Step 1:
Deviation Sales from Base Price/unit -30% 0% $11.60 30% NPV Set up the Data Table by typing in the labels and numbers shown here. The column for sales price/unit is the input range and the column for NPV is the output range. Data Tables take each input value and then automatically calculate a new output based on the input. Be sure to type in the actual sales price of $11.60 and not a formula. Every year we have students who make this mistake! Don't be one of them!

Step 2:
Deviation Sales from Base Price/unit -30% $8.12 0% $11.60 30% $15.08 NPV Enter the formula =$B$117*(1+A116) into the light green cell and then copy it into the light blue cell. This sets up the input range's values of sales prices for which you want new NPV's to be calculated. It is ok to have a formula in the input range, but be sure that none of these inputs is a formula that refers back to the actual value of sales in the input section of the worksheet.

Step 3:
Deviation Sales from Base Price/unit -30% $8.12 0% $11.60 30% $15.08 Deviation Sales from Base Price/unit -30% $8.12 0% $11.60 30% $15.08 Enter into the tan cell a formula that refers to the cell in the NPV results section which shows the NPV for the given set of inputs. In $1,695.11 this example, that is =$I$15. Notice that the tan cell will show the current value of NPV.

Now use your cursor to hightlight the range we show in gray (this NPV $1,695.11 is called the Data Table range); notice that this highlighted range includes the cells for the new inputs for price and the cell for the reference to NPV.

With the range still highlighted, open the Table dialog box. In Excel 2003, you go the Main Menu, select Data, then Table. In Excel 2007, select Data, What-IfAnalysis, then Data Table.

This next step is a bit tricky, so be careful. The cursor in the dialog box will be blinking in the "Row input cell:" box. Here you have to tell Excel if the inputs in your Data Table are arranged in a row or a column. Excel assumes a row, but this is not correct in our example--your inputs are in a column, Column B. So, you click on the "Column input cell" box, causing the cursor to blink in that box.

This next step is a bit tricky, so be careful. The cursor in the dialog box will be blinking in the "Row input cell:" box. Here you have to tell Excel if the inputs in your Data Table are arranged in a row or a column. Excel assumes a row, but this is not correct in our example--your inputs are in a column, Column B. So, you click on the "Column input cell" box, causing the cursor to blink in that box.

Excel wants to know where the input variable, sales price, first enters the model. If you look up in the Input Data section, you will see that it enters in cell E21, so you type E21 in the Column input cell (or click on cell E21 to enter it). Here's the final, completed, dialog box:

When you click OK, Excel will calculate NPV at the three input values specified in your Data Table, insert them in the table, leaving the Data Table as shown below. Deviation from Base -30% 0% 30% Price $8.12 $11.60 $15.08 NPV $1,695.11 -$3,302.36 $1,509.84 $6,322.05

We used Data Tables to create inputs for the sensitivity graph. (First, be sure the Base-Case scenario is showing.) Note that the portion of the rows that are in the Data Tables are shown in shaded colors.
Sales

Deviation Equipment from Base -30% $2,380 0% 3,400 30% 4,420 Deviation from Base -30% 0% 30%
VC/Unit

NPV $1,695 $2,375 1,695 1,015 NPV $1,695 $4,238 1,695 -848

Deviation Unit Sales from Base -30% 385 0% 550 30% 715 Deviation from Base -30% 0% 30%
Non-VC

NPV Deviation Price/unit $1,695 from Base -$1,687 -30% $8.12 185 0% 11.60 2,057 30% 15.08 NPV $1,695 $2,868 1,695 522 Deviation from Base -30% 0% 30%
Project WACC

NPV $1,695 -$3,302 1,510 6,322 NPV $1,695 $2,160 1,695 1,280

$4.20 6.00 7.80

$1,400 2,000 2,600

7.00% 10.00% 13.00%

The following graph is meaningful only if the scenario is set to the BaseCase.

Figure 11-3. Sensitivity Graph for Solar Water Heater Project (Dollars in Thousands)
NPV ($) $8,000 Price $6,000

$4,000

$2,000

Units WACC Equipment Non-VC

$0 VC/Unit -$2,000

-40%

-30%

-20%

-$4,000 -45%

-30%

-15%

0%

15%

30%

45%

% Deviation from Base

Data for Sensitivity Graph

Deviation NPV with Variables at Different Deviations from Base from Base Equipment Price Units VC/Unit Non-VC WACC -30% $2,375 -$3,302 -$1,687 $4,238 $2,868 $2,160 0% $1,695 $1,510 $185 $1,695 $1,695 $1,695 30% $1,015 $6,322 $2,057 -$848 $522 $1,280 Range $1,361 $9,624 $3,744 $5,085 $2,346 $880

Tornado Diagrams
Tornado diagrams are another way to present results from sensitivity analysis. The first step is to rank the range of possible NPV's for each of the input variables that is being changed. In our example, the range for sales price/unit is the largest and the range for WACC is the smallest. The ranges for each variable are then plotted, with the largest range on top and the smallest range on the bottom. It is helpful to also plot a vertical line showing the base-case NPV. We present a tornado diagram in Figure 11-4. Notice that the diagram is like a tornado in that it is widest at the top and smallest at the bottom, hence its name. The tornado diagram makes it immediately obvious which inputs have the biggest impact on NPV.

Tornado diagrams are another way to present results from sensitivity analysis. The first step is to rank the range of possible NPV's for each of the input variables that is being changed. In our example, the range for sales price/unit is the largest and the range for WACC is the smallest. The ranges for each variable are then plotted, with the largest range on top and the smallest range on the bottom. It is helpful to also plot a vertical line showing the base-case NPV. We present a tornado diagram in Figure 11-4. Notice that the diagram is like a tornado in that it is widest at the top and smallest at the bottom, hence its name. The tornado diagram makes it immediately obvious which inputs have the biggest impact on NPV. Additional data for Tornado Diagram -$4,000 -$2,000

Rank
For diagram below

Scratch for Tornado Rank of Range of NPV from Sensitivity Table Above Diagram Below Equipment Price Units VC/Unit Non-VC WACC Base NPV = Y-axis 2 6 4 5 3 1 $1,510 8 2 2 6 6 4 4 5 5 3 3 1 1 1,510 1,510 6 1

Figure 11-4. Tornado Diagram for Solar Water Heater Project: Range of Outcomes for Input Deviations from Base-Case (Dollars

NPV -$4,000 -$2,000 $0 $2,000 $4,000 $6,000 $8,000

Base NPV = $1,510

Price VC/Unit Units Non-VC Equipment WACC

NPV Breakeven Analysis

In breakeven analysis, we find the value of the input variable that produes a zero NPV. It is easiest to do this with Goal Seek. For example, the screen shot below shows the Goal Seek inputs we used to set the cell for NPV to a value of zero by changing the cell for the sales price. We repeated this for the other inputs.

Table 11-1. NPV Breakeven Analysis (Dollars in Thousands)

Input Input Value that Produces Zero NPV Sales price per unit, Year 1 $11.57 Variable cost per unit (VC), Year 1 $6.03 Annual change in units sold, after Year 1 3.58% Units sold, Year 1 547 Nonvariable cost (Non-VC), Year 1 $2,018 Project WACC 10.35%

Data Tables: Multiple Outputs for a Single Input

Data tables can easily be extended to show multiple outputs for a single input. Simply add an additional column with a cell reference to the desired additional output. Highlight the specified values for the input and highlight all the columns for the output as we show shaded in gray below (be sure to also highlight the cell references above the outputs). Then use the Data, Tables, and set "Column input" to the cell refernce of the desired input. Example: NPV and IRR for Changes in Sales Price
% Deviation from Base Case

-30% -15% 0% 15% 30%

SALES PRICE Sales NPV Price $1,695 $8.12 -$3,302 $9.86 -$896 $11.60 $1,510 $13.34 $3,916 $15.08 $6,322

IRR 25.0% -30.6% 1.0% 23.4% 41.9% 58.1%

Two-Way Data Tables: Two Inputs and One Output

Data tables can also be extended to show the output given two inputs. Put one set of input variables in the left-most column of the data table (shown in a red font below) and the other set of inputs in the top row of the data table (shown in white font); put the cell reference to the output you want (like NPV) in the intersection of the row and column for inputs (we show this in a pale green font). Highlight the range that includes the specified values for the inputs, as shown in the gray shaded region below (this will also highlight the cell reference for the output). Then use the Data, Tables, and set "Row input" to the cell reference for the inputs shown in the table's row E19 for units sold) and set "Column input" to the cell refernce for the input shown in the table's column E21 for sales price).

the other set of inputs in the top row of the data table (shown in white font); put the cell reference to the output you want (like NPV) in the intersection of the row and column for inputs (we show this in a pale green font). Highlight the range that includes the specified values for the inputs, as shown in the gray shaded region below (this will also highlight the cell reference for the output). Then use the Data, Tables, and set "Row input" to the cell reference for the inputs shown in the table's row E19 for units sold) and set "Column input" to the cell refernce for the input shown in the table's column E21 for sales price). Example: NPV for Changes in Sales Price and Units Sold % Deviation from Base Case -15% 0% 15%

-30% % Deviation from Base Case -30% -15% 0% 15% 30% NPV cell reference $1,695 $8.12 $9.86 $11.60 $13.34 $15.08

30%

385 -$4,504 -$3,148 -$1,791 -$435 $921

468 -$4,171 -$2,525 -$878 $769 $2,416

Units Sold 550 -$3,839 -$1,901 $36 $1,973 $3,910

633 -$3,506 -$1,278 $949 $3,177 $5,405

715 -$3,174 -$655 $1,863 $4,382 $6,900

Sales Price

$8,000 $6,000 Equipment $4,000 $2,000 $0 -20% -10% -$2,000 -$4,000 0% 10% 20% 30% 40% Price Units VC/Unit Non-VC WACC

7 6 5 4 3 2 1 Equipment Price Units VC/Unit Non-VC WACC

1 0 -$2,000 $0 $2,000 $4,000 $6,000 $8,000

WACC

A B C D E F G H I 5 Tab 1 contains the basic model. It calculates an expansion project's cash flows and performance 6 measures using base-case, or most likely, values for the input variables. It also includes the basic 7 analysis but with straight-line depreciation. 8 9 Tab 2 extends the basic model (shown in Tab 1) to include sensitivity analysis using Data Tables 10 (we include a brief tutorial on the use of Data Tables). Tab 2 also illustrates special cases of 11 sensitivity analysis, incuding breakeven analysis, one-way data tables with multiple outputs, and two12 way data tables. 13 14 Tab 3 extends the basic model (shown in Tab 1) to include scenario analysis, including the use of 15 Scenario Manager. 16 17 Tab 4 extends the basic model (shown in Tab 1) to include simulation analysis. 18 19 Tab 5 illustrates the the analysis for a proposed cost-reducing replacement investment. 20 Replacement decisions differ from expansion decisions because most of the cash flows are found by 21 subtracting the old project's cash flows from those of the new project to calculate incremental 22 cash flows for use in the analysis. 23 24 Tab 6 extends the scenario analysis in Tab 3 to examine two decision trees in which the decision is 25 made in stages. The first one simply shows the situation where the firm can abandon the project if 26 things are not working out and cash flows are negative. The second one involves a marketing study 27 and a prototype of the final product designed to learn more about demand before deciding to go into 28 full production. 29 30 Tab 7 or "App. A" provides depreciation tables as described in Appendix A of the textbook. 31 32 Tab 8 shows the Scenario Summary worksheet if Excel's Scenario Analysis tool is used in Tab 3. 33 34 35 36 37 38 39 40 41 42 43

ANALYSIS OF AN EXPANSION PROJECT (Section 11.2)

The model uses the "Base-Case" input values shown below to calculate the NPV and other performance measures. The main model assumes that the firm uses accelerated depreciation. A modified version of the model, shown in Columns J through R, shows the results if the firm elects to use straight-line depreciation. This analysis demonstrates that accelerated depreciation improves project profitability.

Figure 11-1. Analysis of an Expansion Project: Inputs and Key Results (Dollars in Thousands

44 Part 1. Inputs and Key Results 45 46 47 48 49 50

Inputs
Equipment cost Salvage value, equipment, Year 4 Opportunity cost Externalities (cannibalization)

Base-Case
$3,400 $300 $0 $0 NPV IRR MIRR PI

Key Results
$36 10.35% 10.23% 1.01

51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99

A B C D Units sold, Year 1 Annual change in units sold, after Year 1 Sales price per unit, Year 1 Annual change in sales price, after Year 1 Variable cost per unit (VC), Year 1 Annual change in VC, after Year 1 Nonvariable cost (Non-VC), Year 1 Annual change in Non-VC, after Year 1 Project WACC Tax rate Working capital as % of next year's sales

E 550 4.00% $11.60 2.00% $6.00 2.00% $2,000 2.00% 10.00% 40.00% 12.65%

G H Payback Discounted payback

I 3.41 3.98

If you change any of the blue values in the Input Section shown above, the model below will change instantly, causing changes in NPV and other output variables. You can see the effect in the Key Results box shown above. If you change an input value but later want to return to the base case, use Scenario Manager to select the Base-Case. In Excel 2003, select Tools, Scenarios. In Excel 2007, select Data, What-If-Analysis, Scenario Manager.

Figure 11-2. Analysis of a New (Expansion) Project: Cash Flows and Performance Measures

Part 2. Cash Flows and Performance Measures

Variables Used in the Cash Flow Forecast Unit sales Sales price per unit Variable cost per unit Nonvariable costs (excluding depreciation) 0 2 3 550 572 595 $11.60 $11.83 $12.07 $6.00 $6.12 $6.24 $2,000 $2,040 $2,081 Cash Flows At End of Year 1 2 3 1 4 619 $12.31 $6.37 $2,122 4

Investment Outlays at Time = 0

Equipment Initial investment in working capital Opportunity cost, after taxes

0 -$3,400 -807 0

Net Cash Flows Over the Project's Life

Sales revenues = Units Price/unit Variable costs = Units Cost/unit Nonvariable costs (excluding depreciation) Depreciation: Accelerated, from table below Operating profit (EBIT) Taxes on operating profit Net operating profit after taxes Add back depreciation Opportunity cost, after taxes Cannibalization or complementary effects, after taxes Salvage value (taxed as ordinary income) Tax on salvage value (SV is taxed at 40%) Change in WC: Outflow () or recovery (+) $6,380 3,300 2,000 1,122 -$42 -17 -$25 1,122 0 0 $6,768 3,501 2,040 1,530 -$303 -121 -$182 1,530 0 0 $7,179 3,713 2,081 510 $875 350 $525 510 0 0 $7,616 3,939 2,122 238 $1,316 526 $790 238 0 0 300 -120 963

-49

-52

-55

A 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118

Project net cash flows: Time Line

Project Evaluation

-$4,207

$1,048

$1,296

$980

$2,171

Accelerated Results Formulas NPV =NPV(E59,F101:I101)+E101 $36 IRR =IRR(E101:I101) 10.35% MIRR =MIRR(E101:I101,E59,E59) 10.23% Profitability index =NPV(E59,F101:I101)/(-E101) 1.01 Payback =PERCENTRANK(E112:I112,0,6)*I111 3.41 =PERCENTRANK(E114:I114,0,6)*I111 Discounted payback 3.98 Calculations for Payback Year: 0 1 2 Cumulative cash flows for payback -$4,207 -$3,159 -$1,863 Discounted cash flows for disc. payback -$4,207 $952 $1,071 Cumulative discounted cash flows -$4,207 -$3,255 -$2,183 Accelerated Depreciation Depreciable basis: $3,400 Rate/year 33% 45% Dollars/year $1,122 $1,530

Straight Line Results -$18 9.83% 9.88% 1.00 3.47 #N/A 3 4 -$883 $1,288 $736 $1,483 -$1,447 $36 15% $510 7% $238

10/19/2010

Section 11.5 Sensitivity Analysis

Tab 2 extends the basic model (shown in Tab 1) to include sensitivity analysis. Tab 2 also illustrates special cases of sensitivity analysis, incuding breakeven analysis, one-way data tables with multiple outputs, and two-way data tables. We also include a brief tutorial for Data Tables.

For ease of reference, we repeat Figure 11-1, Analysis of an Expansion Project: Inputs and Key Results (Dollars in Thousands) Part 1. Inputs and Key Results Inputs
Equipment cost Salvage value, equipment, Year 4 Opportunity cost Externalities (cannibalization) Units sold, Year 1 Annual change in units sold, after Year 1 Sales price per unit, Year 1 Annual change in sales price, after Year 1 Variable cost per unit (VC), Year 1 Annual change in VC, after Year 1 Nonvariable cost (Non-VC), Year 1 Annual change in Non-VC, after Year 1 Project WACC Tax rate Working capital as % of next year's sales

Base-Case
$3,400 $300 $0 $0 550 4.00% $11.60 2.00% $6.00 2.00% $2,000 2.00% 10.00% 40.00% 12.65%

Key Results
NPV IRR MIRR PI Payback Discounted payback $36 10.35% 10.23% 1.01 3.41 3.98

If you change any of the blue values above, the model below will change instantly, causing changes in NPV and other output variables. You can see the effect in the Key Results box shown above. If you change an input value but later want to return to the base case, use Scenario Manager to select the Base-Case. In Excel 2003, select Tools, Scenarios. In Excel 2007, select Data, What-If-Analysis, Scenario Manager.

For ease of reference, we repeat Figure 11-2. Analysis of a New (Expansion) Project: Cash Flows and Performance Measures (Dollars in Thousands)

Part 2. Cash Flows and Performance Measures

Variables Used in the Cash Flow Forecast Unit sales Sales price per unit Variable cost per unit Nonvariable costs (excluding depreciation) 0 1 550 $11.60 $6.00 $2,000 2 572 $11.83 $6.12 $2,040 3 595 $12.07 $6.24 $2,081 4 619 $12.31 $6.37 $2,122

Investment Outlays at Time = 0

Equipment Initial investment in working capital Opportunity cost, after taxes

0 -$3,400 -807 0

Cash Flows At End of Year 1 2 3

Net Cash Flows Over the Project's Life

Sales revenues = Units Price/unit Variable costs = Units Cost/unit Nonvariable costs (excluding depreciation) Depreciation: Accelerated, from table below Operating profit (EBIT) Taxes on operating profit Net operating profit after taxes Add back depreciation Opportunity cost, after taxes Cannibalization or complementary effects, after taxes Salvage value (taxed as ordinary income) Tax on salvage value (SV is taxed at 40%) Change in WC: Outflow () or recovery (+) $6,380 3,300 2,000 1,122 -$42 -17 -$25 1,122 0 0 $6,768 3,501 2,040 1,530 -$303 -121 -$182 1,530 0 0 $7,179 3,713 2,081 510 $875 350 $525 510 0 0 $7,616 3,939 2,122 238 $1,316 526 $790 238 0 0 300 -120 963

-49

-52

-55

Project net cash flows: Time Line

Project Evaluation
Results

-$4,207

$1,048

$1,296

$980

$2,171

NPV IRR MIRR Profitability index Payback Discounted payback

Calculations for Payback

$36 10.35% 10.23% 1.01 3.41 3.98 2 -$1,863 $1,071 -$2,183 45% $1,530 3 -$883 $736 -$1,447 15% $510 4 $1,288 $1,483 $36 7% $238

Year: 0 1 Cumulative cash flows for payback -$4,207 -$3,159 Discounted cash flows for disc. payback -$4,207 $952 Cumulative discounted cash flows -$4,207 -$3,255 Accelerated Depreciation Depreciable basis: $3,400 Rate/year 33% Dollars/year $1,122

SENSITIVITY ANALYSIS (Section 11.5)

Risk in capital budgeting really means the probability that the actual outcome will be worse than the expected outcome. For example, if there were a high probability that the expected NPV as calculated above will actually turn out to be negative, then the project would be classified as relatively risky. The reason for a worse-than-expected outcome is, typically, because sales were lower than expected, costs were higher than expected, or the project turned out to have a higher than expected initial cost. In other words, if the assumed inputs turn out to be worse than expected, then the output will likewise be worse than expected. We use data tables below to examine the project's sensitivity to changes in the input variables.

Following is a tutorial for constructing a Data Table to be used in sensitivity analysis. This section may be skipped if you already know how to construct data tables. Instructions for Constructing Data Tables: Step 1:
Deviation Sales from Base Price/unit -30% 0% $11.60 30% NPV Set up the Data Table by typing in the labels and numbers shown here. The column for sales price/unit is the input range and the column for NPV is the output range. Data Tables take each input value and then automatically calculate a new output based on the input. Be sure to type in the actual sales price of $11.60 and not a formula. Every year we have students who make this mistake! Don't be one of them!

Step 2:
Deviation Sales from Base Price/unit -30% $8.12 0% $11.60 30% $15.08 NPV Enter the formula =$B$117*(1+A116) into the light green cell and then copy it into the light blue cell. This sets up the input range's values of sales prices for which you want new NPV's to be calculated. It is ok to have a formula in the input range, but be sure that none of these inputs is a formula that refers back to the actual value of sales in the input section of the worksheet.

Step 3:
Deviation Sales from Base Price/unit -30% $8.12 0% $11.60 30% $15.08 Deviation Sales from Base Price/unit -30% $8.12 0% $11.60 30% $15.08 Enter into the tan cell a formula that refers to the cell in the NPV results section which shows the NPV for the given set of inputs. In $35.84 this example, that is =$I$15. Notice that the tan cell will show the current value of NPV.

Now use your cursor to hightlight the range we show in gray (this NPV $35.84 is called the Data Table range); notice that this highlighted range includes the cells for the new inputs for price and the cell for the reference to NPV.

With the range still highlighted, open the Table dialog box. In Excel 2003, you go the Main Menu, select Data, then Table. In Excel 2007, select Data, What-IfAnalysis, then Data Table.

This next step is a bit tricky, so be careful. The cursor in the dialog box will be blinking in the "Row input cell:" box. Here you have to tell Excel if the inputs in your Data Table are arranged in a row or a column. Excel assumes a row, but this is not correct in our example--your inputs are in a column, Column B. So, you click on the "Column input cell" box, causing the cursor to blink in that box.

This next step is a bit tricky, so be careful. The cursor in the dialog box will be blinking in the "Row input cell:" box. Here you have to tell Excel if the inputs in your Data Table are arranged in a row or a column. Excel assumes a row, but this is not correct in our example--your inputs are in a column, Column B. So, you click on the "Column input cell" box, causing the cursor to blink in that box.

Excel wants to know where the input variable, sales price, first enters the model. If you look up in the Input Data section, you will see that it enters in cell E21, so you type E21 in the Column input cell (or click on cell E21 to enter it). Here's the final, completed, dialog box:

When you click OK, Excel will calculate NPV at the three input values specified in your Data Table, insert them in the table, leaving the Data Table as shown below. Deviation from Base -30% 0% 30% Price $8.12 $11.60 $15.08 NPV $35.84 -$3,838.74 $35.84 $3,910.42

We used Data Tables to create inputs for the sensitivity graph. (First, be sure the Base-Case scenario is showing.) Note that the portion of the rows that are in the Data Tables are shown in shaded colors.
Sales

Deviation Equipment from Base -30% $2,380 0% 3,400 30% 4,420 Deviation from Base -30% 0% 30%
VC/Unit

NPV $36 $716 36 -645 NPV $36 $2,083 36 -2,011

Deviation Unit Sales from Base -30% 385 0% 550 30% 715 Deviation from Base -30% 0% 30%
Non-VC

NPV Deviation Price/unit $36 from Base -$1,791 -30% $8.12 36 0% 11.60 1,863 30% 15.08 NPV $36 $1,209 36 -1,137 Deviation from Base -30% 0% 30%
Project WACC

NPV $36 -$3,839 36 3,910 NPV $36 $361 36 -254

$4.20 6.00 7.80

$1,400 2,000 2,600

7.00% 10.00% 13.00%

The following graph is meaningful only if the scenario is set to the BaseCase.

Figure 11-3. Sensitivity Graph for Solar Water Heater Project (Dollars in Thousands)
NPV ($) $6,000

$4,000

Price

$2,000

Units

$0

WACC Equipment Non-VC VC/Unit

-$2,000

-40%
-$4,000

-30%

-20%

-$6,000 -45%

-30%

-15%

0%

15%

30%

45%

% Deviation from Base

Data for Sensitivity Graph

Deviation NPV with Variables at Different Deviations from Base from Base Equipment Price Units VC/Unit Non-VC WACC -30% $716 -$3,839 -$1,791 $2,083 $1,209 $361 0% $36 $36 $36 $36 $36 $36 30% -$645 $3,910 $1,863 -$2,011 -$1,137 -$254 Range $1,361 $7,749 $3,655 $4,095 $2,346 $615

Tornado Diagrams
Tornado diagrams are another way to present results from sensitivity analysis. The first step is to rank the range of possible NPV's for each of the input variables that is being changed. In our example, the range for sales price/unit is the largest and the range for WACC is the smallest. The ranges for each variable are then plotted, with the largest range on top and the smallest range on the bottom. It is helpful to also plot a vertical line showing the base-case NPV. We present a tornado diagram in Figure 11-4. Notice that the diagram is like a tornado in that it is widest at the top and smallest at the bottom, hence its name. The tornado diagram makes it immediately obvious which inputs have the biggest impact on NPV.

Tornado diagrams are another way to present results from sensitivity analysis. The first step is to rank the range of possible NPV's for each of the input variables that is being changed. In our example, the range for sales price/unit is the largest and the range for WACC is the smallest. The ranges for each variable are then plotted, with the largest range on top and the smallest range on the bottom. It is helpful to also plot a vertical line showing the base-case NPV. We present a tornado diagram in Figure 11-4. Notice that the diagram is like a tornado in that it is widest at the top and smallest at the bottom, hence its name. The tornado diagram makes it immediately obvious which inputs have the biggest impact on NPV. Additional data for Tornado Diagram -$6,000 -$4,000

Rank
For diagram below

Scratch for Tornado Rank of Range of NPV from Sensitivity Table Above Diagram Below Equipment Price Units VC/Unit Non-VC WACC Base NPV = Y-axis 2 6 4 5 3 1 $36 8 2 2 6 6 4 4 5 5 3 3 1 1 36 36 6 1

Figure 11-4. Tornado Diagram for Solar Water Heater Project: Range of Outcomes for Input Deviations from Base-Case (Dollars

NPV -$6,000 -$4,000 -$2,000 $0 Base NPV = $36 $2,000 $4,000 $6,000

Price VC/Unit Units Non-VC Equipment WACC

NPV Breakeven Analysis

In breakeven analysis, we find the value of the input variable that produes a zero NPV. It is easiest to do this with Goal Seek. For example, the screen shot below shows the Goal Seek inputs we used to set the cell for NPV to a value of zero by changing the cell for the sales price. We repeated this for the other inputs.

Table 11-1. NPV Breakeven Analysis (Dollars in Thousands)

Input Input Value that Produces Zero NPV Sales price per unit, Year 1 $11.57 Variable cost per unit (VC), Year 1 $6.03 Annual change in units sold, after Year 1 3.58% Units sold, Year 1 547 Nonvariable cost (Non-VC), Year 1 $2,018 Project WACC 10.35%

Data Tables: Multiple Outputs for a Single Input

Data tables can easily be extended to show multiple outputs for a single input. Simply add an additional column with a cell reference to the desired additional output. Highlight the specified values for the input and highlight all the columns for the output as we show shaded in gray below (be sure to also highlight the cell references above the outputs). Then use the Data, Tables, and set "Column input" to the cell refernce of the desired input. Example: NPV and IRR for Changes in Sales Price
% Deviation from Base Case

-30% -15% 0% 15% 30%

SALES PRICE Sales NPV Price $36 $8.12 -$3,839 $9.86 -$1,901 $11.60 $36 $13.34 $1,973 $15.08 $3,910

IRR 10.4% -45.0% -11.3% 10.4% 27.8% 42.8%

Two-Way Data Tables: Two Inputs and One Output

Data tables can also be extended to show the output given two inputs. Put one set of input variables in the left-most column of the data table (shown in a red font below) and the other set of inputs in the top row of the data table (shown in white font); put the cell reference to the output you want (like NPV) in the intersection of the row and column for inputs (we show this in a pale green font). Highlight the range that includes the specified values for the inputs, as shown in the gray shaded region below (this will also highlight the cell reference for the output). Then use the Data, Tables, and set "Row input" to the cell reference for the inputs shown in the table's row E19 for units sold) and set "Column input" to the cell refernce for the input shown in the table's column E21 for sales price).

the other set of inputs in the top row of the data table (shown in white font); put the cell reference to the output you want (like NPV) in the intersection of the row and column for inputs (we show this in a pale green font). Highlight the range that includes the specified values for the inputs, as shown in the gray shaded region below (this will also highlight the cell reference for the output). Then use the Data, Tables, and set "Row input" to the cell reference for the inputs shown in the table's row E19 for units sold) and set "Column input" to the cell refernce for the input shown in the table's column E21 for sales price). Example: NPV for Changes in Sales Price and Units Sold % Deviation from Base Case -15% 0% 15%

-30% % Deviation from Base Case -30% -15% 0% 15% 30% NPV cell reference $36 $8.12 $9.86 $11.60 $13.34 $15.08

30%

385 -$4,504 -$3,148 -$1,791 -$435 $921

468 -$4,171 -$2,525 -$878 $769 $2,416

Units Sold 550 -$3,839 -$1,901 $36 $1,973 $3,910

633 -$3,506 -$1,278 $949 $3,177 $5,405

715 -$3,174 -$655 $1,863 $4,382 $6,900

Sales Price

$5,000 $4,000 $3,000 $2,000 $1,000 $0 -20% -10% 0% -$1,000 -$2,000 -$3,000 -$4,000 -$5,000 10% 20% 30% 40% Equipment Price Units VC/Unit Non-VC WACC

7 6 5 4 3 2 1 Equipment Price Units VC/Unit Non-VC WACC

1 0 -$4,000 -$2,000 $0 $2,000 $4,000 $6,000

WACC

Scenario analysis extends risk analysis in two ways: (1) It allows us to change more than one variable at a time, hence to see the combined effects of changes in several variables on NPV, and (2) It allows us to bring in the probabilities of changes in the key variables. Figure 11.6 (shown below) presents the cash flows for each scenario (the cash flows are obtained from the 3 scenarios' analsyes conducted above in the blue, bright yellow, and green boxes). It also shows the NPV for each scenario. Using the NPV and probability for each scenario, we calculate the expected NPV, the standard deviation, and the coefficient of variation. Later in the analysis we consider the possibility of abandoning the project if the worst case occurs, but our present analysis assumes that we cannot abandon the project.

Note: the scenario analysis below is meaningful only if the values in the input section in Cells E37:E51 are set to the original base-case.

Figure 11-6. Scenario Analysis: Expected NPV and Its Risk (Dollars in Thousands)
Prob: 25% 50% 25% Predicted Cash Flows for Alternative Scenarios 0 1 2 3 -$3,812 $3,813 $4,634 $5,256 -$4,207 -$4,703 $1,048 -$283 $1,296 -$64 $980 -$737 4 $8,705 $2,171 WACC 10.00% 10.00% NPV $13,379 $36 -$5,847 $1,901 $7,049 3.71
Calculating Deviation
11478 -1865 -7748

st Be
1 Base

Wo rst

-$410 10.00% Expected NPV = Standard Deviation (SD) = Coefficient of Variation (CV) = Std. Dev./Expected NPV =

Probability Distribution of Scenarios: Outcomes and Probabilities

50%

25%

25%

Worst-Case -$5,847

Most-Likely $36 Expected NPV $1,901

NPV

Best-Case $13,379

Scenario Manager
Rather than have 3 sets of analyses, it is possible to have only one set and use the Excel feature called Scenario Manager. (To open the Scenario Manager dialog box in Excel 2003, select Tools, Scenarios; in Excel 2007, select Data, What-if-Analysis, then Scenarios.) If you open the Scenario Manager dialog box, you see the box shown below:

Rather than have 3 sets of analyses, it is possible to have only one set and use the Excel feature called Scenario Manager. (To open the Scenario Manager dialog box in Excel 2003, select Tools, Scenarios; in Excel 2007, select Data, What-if-Analysis, then Scenarios.) If you open the Scenario Manager dialog box, you see the box shown below:

-$10,000

You can select a scenario, click "Show", and the values for that scenario will be substituted into the input cells in Column E (E35:E51). So if we had not repeated the analysis in Columns K through AC, Scenario Manager makes it easy to show any set of inputs in a single model for analysis. Scenario Manager also makes it easy to create a summary of all scenarios using the Summary feature in the dialog box shown above. For example, if you select Summary, you will see the box below:

We selected the cells with key results, E53:E58. When you click OK, the output of the summary will be created in a new worksheet; this new worksheet is "8. Scenario Summary". It provides the same key results as the three separate analyses did, but you need only to create one analysis with multiple sets of inputs saved as scenarios. We encourgage you to explore the Scenaro Manager feature in our Excel Tutorial.

Figure 11-6.

Scenario Analysis: Can Abandon

s Be
1

Prob: 25% 50%

Predicted Cash Flows for Alternative Scenarios 0 1 2 3 -$3,812 $3,813 $4,634 $5,256 -$4,207
-$4,703

4 $8,705 $2,171
-$410

WACC 10.00% 10.00%

NPV $13,379 $36

Calculating Deviation
$11,153 -$2,190

Base

$1,048
-$283

$1,296
-$64

$980
-$737 2

Wo

rst

25% $0 10.00% Expected NPV = Standard Deviation (SD) = Coefficient of Variation (CV) = Std. Dev./Expected NPV = $500 $0 -$4,547 $2,226 $6,706 3.01
-$6,773

-$4,703 -$283 If abandon, can liquidate for $500 at t = 2.

Figure 11-7. Decision Tree with Multiple Decision Points

Section 11.7 Scenario Analysis

Note: this section is relatively technical and some instructors may choose to skip it with no loss in continu

Monte Carlo simulation is similar to scenario analysis in that different values of key inputs are used. Unlike scenario analysis, Monte Carlo simulation draws a trial set of input values from specified probability distributions and then computes the NPV for this trial. This process is repeated for hundreds, or even thousands, of trials, with key results ( NPV) saved from each trial. After running the number of desired trials, the NPVs from the trials can be averaged to estimate the project's expected NPV; the trial results can also be used to provide a histogram showing the project's possible outcomes.

Panel A, shown in the blue-bordered box below and slightly to the right, shows the inputs from the previous scenario analysis. It also shows the expected value and standard deviation for those inputs based on the probability of each scenario. To compare apples and apples, we will assume that the inputs for the simulation analysis are drawn from a normal distribution with the same expected value and standard deviation as the inputs from the scenario analysis (the are shown Figure 11-7 in blue in Columns C and D below. However, any of the the blue values in Columns C and D ma changed by the user if desired. Cell D53 also has the input for the assumed correlation between units sold in Year 1 an changes in units sold in later years.

Fgirue 11-7, shown in the box below, also shows the trial inputs and key results. The inputs are shown in red and are drawn from a normal distribution with the mean and standard deviation specified in Columns C and D. We do this in a step process. Column E shows a standard normal random variable created with Excel's random number generator. Column F transforms the standard normal random variable into a normal random variable with the desired mean and standard deviation. To see updated values,hit the F9 key. Figure 11-7: Inputs and Key Results for the Current Simulation Trial (Dollars in Thousands) To change an input, change one of the blue values in Columns C or D. To see an updated set of trial values, hit the F9 key. Inputs and key results will update for the current trial. Inputs for Simulation Random Variables Used Probability in Current Simulation Distributions Trial Expected Value of Input Standard Deviation of Input Standard Normal Random Variable -1.29 Value used in Current Trial

Inputs:
Equipment cost Salvage value, equipment, Year 4 Opportunity cost Externalities (cannibalization) Units sold, Year 1 Annual change in units sold, after Year 1 Sales price per unit, Year 1 Annual change in sales price, after Year 1 Variable cost per unit (VC), Year 1 Annual change in VC, after Year 1

$3,400

$601

$2,622
$300 $0 $0

550 4.00% $11.60 $6.00

98 7.07% $2.05 $1.06

0.12 0.80 0.66 0.54

562 9.69% $12.95

2.00%

$6.57
2.00%

Nonvariable cost (Non-VC), Year 1 Annual change in Non-VC, after Year 1 Project WACC Tax rate Working capital as % of next year's sales Assumed correlation between units sold in Year 1 and annual change in units sold in later years:

$2,000

$354

-0.68

$1,758
2.00% 10.00%

40.00%

7.07%

0.51

43.58%
12.65%

r=

65.00%

Key Results Based on Current Trial

NPV IRR MIRR PI Payback Discounted payback $2,416 34.14% 25.27% 1.68 2.39 2.87

Panel B: Project Analysis for Current Trial in Simulation

Variables Used in the Cash Flow Forecast
Unit sales Sales price per unit Variable cost per unit Nonvariable costs (excluding depreciation)

Investment Outlays at Time = 0

Equipment Initial investment in working capital Opportunity cost, after taxes

0 -$2,622 -920 0

2 562 616 $12.95 $13.21 $6.57 $6.70 $1,758 $1,793 Cash Flows At End of Year 1 2

Net Cash Flows Over the Project's Life

Sales revenues = Units Price/unit Variable costs = Units Cost/unit Nonvariable costs (excluding depreciation) Depreciation: Accelerated, from table below Operating profit (EBIT) Taxes on operating profit Net operating profit after taxes Add back depreciation Opportunity cost, after taxes Cannibalization or complementary effects, after taxes Salvage value (taxed as ordinary income) Tax on salvage value (SV is taxed at 40%) Change in WC: Outflow () or recovery (+)

$7,274 3,688 1,758 865 $962 419 $543 865 0 0

$8,138 4,126 1,793 1,180 $1,038 452 $586 1,180 0 0

-109

-122

Project net cash flows: Time Line

-$3,543

$1,299

$1,644

Project Evaluation
Results

NPV IRR MIRR Profitability index Payback Discounted payback

Calculations for Payback Cumulative cash flows for payback Discounted cash flows for disc. payback Cumulative discounted cash flows

$2,416 34.14% 25.27% 1.68 2.39 2.87 0 -$3,543 -$3,543 -$3,543 Accelerated Depreciation $2,622 Rate/year Dollars/year Year: 1 -$2,244 $1,181 -$2,362 33% $865 2 -$600 $1,358 -$1,003 45% $1,180

Depreciable basis:

How the Simulation Works

We use a Data Table to perform the simulation (the Data Table is below shaded in lavender). When the Data Table is updated, it will insert new random variables for each of the inputs we allow to change in Figure 11-7 above, run the analysis in Panel B above, and then save the NPV for each trial. (We also save the input variables for each trial so tha can verify that they are behaving as we expect.) We set the first column of the Data Table (the variable to be changed each row) to numbers from 1-100. We don't really use these numbers anywhere in the analyis, but if we tell the Data Ta to treat these as the Column inputs, Excel will recalculate all items in the Data Table, including the random inputs and resulting NPV. In other words, we "trick" Excel into doing a simulation. We tell Excel to insert each of the Column inpu the Data Table into the cell immediately below this box. This cell isn't linked to anything else, but each time Excel upd a row of the Data Table, all the random values will be updated. Column input cell to "trick" Excel into updating random variables in Data Table: 1

Excel normally updates all values in a Data Table each time any cell that is related to the Data Table changes. In our ca we have random variables in the Data Table, so each time any cell in the worksheet makes a calculation, the Data Tab updated. If the Data Table has many rows, updating it can take up to 20 or 30 seconds. This is ok when we want to upd the Table, but it is annoying to wait 30 seconds any time we make any changes in the worksheet. The "check box" explained below helps with this annoyance.

To put random variables in the Data Table for the simulation, the box shown below must be checked; otherwise, the D Table contains only zero's and doesn't update when the sheet makes a calculation (other than the first time you check box or if you insert or delete rows or columns). If the box is unchecked and you check it, the check mark won't show u until the Table is updated, so don't get impatient and click it twice. After you have checked the box, the Data Table wil update any time you change a cell in the worksheet. So to make the Data Table update, make sure the box is checked then hit the F9 key. Put a check in the box below to put trials into the data table; otherwise, the data table will have only zeros. Must be checked to put random variable in data table for simulation TRUE

Remember to uncheck the box above when you are through with the simulation, or the Data Table will recalculate any you make a change in the worksheet, which will slow down all other calculations in the worksheet.

You don't need to change anything in this section. It will be updated automatically if you do a simulation. The summa the simulation results and the histogram are based on the simulation trials n the Data Table below and are updated automatically when you do a simulation.

Note: If results ae all zeros, go back to row 144 and "check" the box by clicking it w
Figure 11-8 Summary of Simulation Results (Thousands of Dollars)
Number of Trials = 100
Annual change in Sales price per unit, Equipment Units sold, units sold, cost Year 1 after Year 1 Year 1

Average Standard deviation Maximum Minimum Correlation with unit sales Median Probability of NPV > 0 Coefficient of variation

$3,335 604 4,592 1,981

555 102 828 348

Simulated Input Variables Variable Nonvariable cost per cost unit (VC), (Non-VC), Year 1 Year 1 3.9% $11.44 $6.00 $1,933 6.7% 1.97 0.97 375 22.6% 15.08 8.09 2,938 -14.3% 6.91 3.07 1,012 63.0%

Probability

-8,417

-4,208

4,208

NPV ($)

12% 10% 8% 6%

6% 4% 2% 0% Series1

Output of Simulation in Data Table

Equipment cost 2622.3692 3488.4395 3165.9124 4124.7734 3693.7535 3557.4374 2640.7468 3163.9442 2770.9975 3155.2457 2853.2333 3496.7466 4102.2308 2355.0426 3152.2162 4196.8925 4023.4005 2987.18 2911.0074 4301.3266 1980.9425 2677.0879 2964.4794 4375.1264 4048.7871 3211.3851 3320.4912 3686.4362 3568.2388 3840.2368 3658.7419 4530.3845 4449.8308 3578.6718 2962.7842 2630.4364 4287.9567 3080.4157 3560.1258 Units sold, Year 1 561.6058 509.72942 586.5598 361.39946 549.89593 428.80496 535.76782 485.89876 585.61224 548.89418 584.57021 643.63082 545.49359 347.69703 686.41055 582.10458 655.89303 584.76277 630.98991 496.74343 411.69364 542.0775 410.78616 645.49644 540.21901 518.95403 560.38227 416.50646 470.65354 542.79043 575.74925 637.53628 568.80557 581.4207 477.26813 576.86678 725.0125 512.44753 626.72216 Annual change in units sold, after Year 1 0.0968561 0.1015748 0.0061014 -0.0490178 0.0256939 -0.1430771 0.0298624 0.0793877 -0.0180154 0.0001514 0.0728919 0.0221398 0.0788997 -0.0722035 0.1344561 0.0378465 0.0776536 0.0438849 0.181372 -0.0020466 -0.0033495 -0.0718277 -0.0594206 -0.0007558 0.003643 -0.041362 0.0699445 -0.0515279 0.0143096 0.0871254 0.0590766 0.1178159 -0.0252048 0.1053548 0.0835297 0.1443104 0.1783452 0.0230596 0.0487387 Sales price Variable per unit, cost per unit Year 1 (VC), Year 1 12.9519938 6.567437 11.1991871 5.7894251 10.0568104 4.4487141 13.1979145 7.3525776 10.8455174 6.4042798 10.7331397 6.3300401 12.6381583 5.5679636 13.0353768 5.423323 14.9153291 4.7952533 11.0990332 4.9294151 10.373161 6.2009411 11.2818564 6.6761267 10.3203474 8.0949165 11.6637088 6.8547593 11.9855589 5.1706924 12.8126799 6.7722038 10.8586119 5.0192485 13.6609879 6.8528955 12.8262653 7.0132329 11.2841409 6.6349215 11.7889839 6.9071368 12.4847718 4.5480288 8.83278508 5.4230551 11.3006835 5.6182022 11.5912086 6.928554 10.3935933 6.8609977 12.1208153 6.0160599 15.0205048 5.1936858 11.1590405 4.8853514 8.48194184 6.3446346 11.9288249 5.297704 9.52410536 5.1052184 13.2421467 4.9642596 13.0404708 5.6618842 12.1646859 6.4339076 7.24251985 6.7961391 10.4950298 5.0109524 10.1125517 6.4975119 10.7465783 6.8587012 Nonvariable cost (NonVC), Year 1 1758.1202 1647.2038 2503.5986 1179.7269 1348.1723 2209.7426 1745.7765 1865.7275 2691.2144 1327.6091 1879.9976 1822.6089 2052.938 2182.9075 1575.8585 1810.1806 1764.0908 1899.9784 2310.0317 2170.9507 2463.7165 1510.6292 1934.4498 1503.5788 2215.6222 2272.824 1911.4418 1838.0415 2129.2433 2187.6658 1729.6719 1146.2684 1896.2001 1379.6762 1692.8272 2028.9789 2686.8728 1921.2695 2366.8163

Trial Number 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38

39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90

3312.9659 3288.7694 2819.4466 3078.6801 2757.6184 3068.1671 4107.8466 3230.2093 4138.7234 2794.8595 2656.5387 3319.7909 2877.4513 3047.6137 4114.2952 2734.2438 3668.8739 2966.8642 3128.8479 3371.5903 3154.8157 3837.7259 2532.1518 2107.2792 2945.9964 3116.7257 4285.0749 2576.0891 3023.4351 3812.9166 2161.6719 3086.8854 3975.3403 3315.4918 4592.4553 3238.3277 3758.4642 4383.3017 3370.0401 2690.6757 3242.7843 2528.0926 3134.5508 2877.2081 4455.9558 3742.0449 4119.2711 3092.3908 3169.74 3618.5058 4004.1886 2616.3208

682.40476 558.31206 599.41864 647.90092 570.85145 538.37366 484.9753 697.36538 593.10499 719.53208 647.57471 634.39365 677.86484 591.10161 695.26802 428.22343 540.81573 511.1259 467.13295 696.81695 467.6091 349.71973 608.29872 505.79647 667.43603 477.34703 828.4037 591.36822 479.22482 553.86708 586.25011 579.96915 442.03835 506.05089 630.69794 463.81777 712.1849 732.69917 362.07292 513.82239 464.64824 512.53044 469.4964 378.61646 370.56129 450.96535 734.70377 487.88297 697.31578 666.54427 502.65668 680.92243

0.0243211 0.0013415 0.047019 0.0543397 0.0634391 0.0781523 0.017052 0.0172192 0.0791493 0.0746759 0.0704944 0.0994683 0.0672602 0.0496073 0.1005516 -0.0030223 -0.0050133 0.0926936 0.1501773 0.176374 0.0427873 -0.1259778 0.0277186 0.0142402 0.1138203 -0.0642892 0.1335538 0.0701069 0.0256256 0.0467946 0.1045122 0.0474641 -0.008321 -0.0286332 0.0880712 -0.0320971 0.0247551 0.1140838 0.0460034 0.0193198 -0.0331509 0.0566818 -0.0285653 -0.0492851 -0.0316262 -0.0398443 0.0977962 0.0270222 0.0126009 0.2258786 -0.0831688 0.1179093

11.2248332 14.9020608 8.01745138 11.4546589 10.1523215 11.1015779 11.36203 12.9004214 13.1584785 10.8080703 14.9628901 11.4027636 9.26977378 12.6880344 11.123747 8.98740674 7.50600669 11.1979876 14.886115 11.1933867 13.4989211 10.6387589 13.9267085 12.4270149 9.82488866 10.7139914 10.6217431 9.78605201 9.83494985 8.51291491 13.4973933 10.6713426 10.261377 8.51980903 13.7002102 14.6173118 9.42282448 11.1997651 9.01426856 11.0207032 12.0602442 14.9465578 15.0807315 9.01032156 10.9106259 10.750425 12.9647713 6.90764729 13.2818707 13.4271157 13.2906928 13.8168369

4.8304464 7.7457814 4.6384563 6.9408404 5.3987689 5.5044889 3.0663815 5.1265695 7.394534 4.3745114 6.1400734 4.9036471 7.0515369 7.0309212 6.5048796 6.6294689 5.503545 7.2168576 6.9437258 5.1562547 5.9759848 3.6355809 6.8141819 6.803386 5.7704826 5.1644117 6.4186791 6.8016716 6.5164841 5.4790987 5.6190456 5.4476185 7.2533268 5.955218 4.9225467 4.9672166 6.2927419 6.1748791 6.2463282 5.3000252 5.8280199 5.9280349 6.9646125 5.5811419 7.9915306 6.4049048 7.3383288 5.783744 4.9996721 7.0292482 4.933032 7.2102258

2478.541 1414.1084 2171.3863 1402.25 1992.5223 2048.0316 1725.6078 1987.4233 1404.5824 1784.6768 1370.0991 1474.5369 1333.7801 1911.6971 2357.3693 1832.2808 2194.975 2265.1151 1888.9135 1705.8609 2781.2767 1488.5611 2331.9937 2577.2276 1712.5237 2111.2394 1286.4267 1709.8458 1864.6775 2102.5343 2361.982 1740.9713 1782.4852 1730.4681 1742.7039 2433.7604 1876.5907 1801.7658 2373.2506 2111.523 2045.9963 1962.7291 2105.1226 1732.053 2193.8618 2138.2824 2328.2726 2073.5258 2937.6679 1813.9535 2174.5715 2107.6607

91 92 93 94 95 96 97 98 99 100

3213.7107 3383.05 2869.8383 2364.5487 3811.8364 4000.0544 3653.0592 3133.1728 2226.1543 3256.4703

580.3141 556.65656 683.13946 538.41431 414.32255 423.05896 731.25608 493.80542 448.39058 510.80078

0.0468372 -0.0632814 0.1065308 0.0766663 -0.0011643 -0.0055125 0.12933 0.0417829 0.0650289 0.0452204

14.5176178 8.77619879 9.06749935 7.35927783 8.72716055 14.0310831 11.2345909 10.6417939 14.0008517 12.947984

6.6150529 5.8249026 6.7729695 4.1275073 7.4421867 5.5071403 5.4380334 5.8097146 6.9232195 6.3231271

1609.9651 1782.7446 2252.4621 1012.21 1969.1969 2128.7538 1809.2684 1491.5753 2216.1412 1919.8913

10/19/2010

p it with no loss in continuity.

s are used. Unlike scenario ty distributions and then ds, of trials, with key results (like e trials can be averaged to gram showing the project's

s from the previous scenario on the probability of each n analysis are drawn from a om the scenario analysis (these alues in Columns C and D may be etween units sold in Year 1 and

uts are shown in red and are mns C and D. We do this in a 2andom number generator. e with the desired mean and

Panel A: Values from Scenario Analysis and Their Expected Values and Standard Deviations

Inputs from Scenario Analysis for Comparison to Simulation Base Worst Probability of Scenario Best Expected Value of Input Standard Deviation of Input

50% $3,400
$300 $0 $0

25% $4,250
$300 $0 $0

25% $2,550
$300 $0 $0

$3,400

$601

550 4.00% $11.60

2.00%

412 -6.00% $8.70

2.00%

688 14.00% $14.50

2.00%

550 4.00% $11.60 $6.00

98 7.07% $2.05 $1.06

$6.00
2.00%

$7.50
2.00%

$4.50
2.00%

$2,000
2.00% 10.00%

$2,500
2.00% 10.00%

$1,500
2.00% 10.00%

$2,000

$354

40.00%
12.65%

50.00%
12.65%

30.00%
12.65%

40.00%

7.07%

Key Results

Base
$36 10.35% 10.23% 1.01 3.41 3.98

Worst

Best

-$5,847 $13,379 Not found 112.01% -100.00% 60.30% -0.24 4.51 Not found 1.00 Not found 1.09

4 741 $13.74 $6.97 $1,866 4

676 $13.48 $6.83 $1,829 ws At End of Year 3

$9,105 4,617 1,829 393 $2,266 987 $1,278 393 0 0

-137

$10,186 5,165 1,866 184 $2,972 1,295 $1,677 184 0 0 300 -131 1,289

$1,535

$3,318

3 $935 $1,153 $150 15% $393

4 $4,253 $2,266 $2,416 7% $184

er). When the Data Table is Figure 11-7 above, run the variables for each trial so that we e (the variable to be changed in alyis, but if we tell the Data Table uding the random inputs and the nsert each of the Column inputs in else, but each time Excel updates

Don't change the the red cell.

Data Table changes. In our case, s a calculation, the Data Table is his is ok when we want to update rksheet. The "check box"

be checked; otherwise, the Data than the first time you check this the check mark won't show up d the box, the Data Table will make sure the box is checked and

ata Table will recalculate any time orksheet.

do a simulation. The summary of ble below and are updated

e box by clicking it with your cursor.

Key Results: Tax rate 40.8% 6.5% 58.0% 24.9% NPV $119 $2,833 $8,417 -$5,870 $419 1.1% 23.81
Scratch work for chart: see comments.

Count Range bottom -$8,417 -$7,815 -$7,214 -$6,613 -$6,012 -$5,411 -$4,809 -$4,208 -$3,607 -$3,006 -$2,405 -$1,804 -$1,202 -$601 $0 $601 $1,202 $1,804 $2,405 $3,006 $3,607 $4,208 $4,809 0 0 0 0 0 2 1 3 4 9 3 6 6 4 8 7 10 9 7 5 4 4 6 1 Percent 0% 0% 0% 0% 2% 1% 3% 4% 9% 3% 6% 6% 4% 8% 7% 10% 9% 7% 5% 4% 4% 6% 1%

8,417

NPV ($)

$5,411 $6,012 $6,613 $7,214 $7,815 $8,417 Sum

0 0 0 0 1 0 100

0% 0% 0% 0% 1% 0% 100%

Tax rate 0.4357544 0.3962658 0.4167836 0.4422345 0.3994013 0.3416429 0.3946599 0.3611902 0.4808557 0.5159397 0.3624559 0.4087118 0.5229853 0.4374843 0.5804654 0.3985948 0.4146322 0.3926339 0.4597516 0.2876229 0.4154213 0.4366951 0.4523089 0.4450466 0.4764578 0.4505411 0.3063633 0.5793528 0.3916977 0.3437655 0.3593476 0.3463385 0.5645988 0.4129504 0.4354831 0.3225147 0.4805507 0.4323282 0.44722

NPV 2416.2969 525.75473 -645.9365 -1236.536 -280.8496 -3997.986 2407.8459 2346.0608 3315.4256 1296.5036 -433.2646 -114.472 -3561.706 -2766.362 3605.5313 713.57368 1936.7712 2382.2467 2122.8541 -3049.784 -2257.868 2522.6365 -3027.199 966.04679 -2055.802 -3077.001 1566.8174 635.50075 -749.9112 -4697.244 2306.2382 1245.3022 1188.2131 4277.2886 498.51933 -5780.272 1204.0683 -2090.606 -1982.768

0.4876061 0.4079493 0.4779785 0.4319572 0.3603688 0.4156353 0.3887544 0.4952948 0.4215689 0.3876445 0.3391589 0.4305478 0.3392065 0.3781571 0.3784685 0.2969238 0.4899364 0.4224528 0.3911517 0.347187 0.5122553 0.4049176 0.2485209 0.3901322 0.3754849 0.2839801 0.4594973 0.3366546 0.3925239 0.4287471 0.3674073 0.4489658 0.3468172 0.3756121 0.5128587 0.2909083 0.4354901 0.3949596 0.4201035 0.4303817 0.3518086 0.4453714 0.4605362 0.2985731 0.4024156 0.3947493 0.4028003 0.283722 0.4514475 0.4380644 0.390927 0.4866962

1210.3817 2600.265 -1815.847 1060.4835 -32.19882 339.15622 1884.5363 3690.5423 1623.2357 4569.6916 8416.5697 3698.6398 -1528.724 1097.702 -347.5963 -3966.645 -4095.133 -1977.564 2984.8131 5128.1133 -469.6715 -1462.711 3086.9791 -917.1335 755.44907 -1706.706 2148.2973 -1469.198 -2540.335 -3116.465 4399.0031 595.03859 -3875.349 -3306.235 4237.7272 1685.5356 -1773.125 1743.8287 -4680.849 -163.1464 -864.8576 3677.8021 631.03849 -3340.025 -5257.688 -3140.57 1625.0649 -5869.948 3001.8271 4660.1075 277.08991 3435.6643

0.3083023 0.4402483 0.3689882 0.3016727 0.5020047 0.3591451 0.4022865 0.4356734 0.3883518 0.3936462

4791.0283 -2723.764 -3047.064 294.92491 -4598.713 111.29932 3649.2911 -201.262 846.43254 974.74993

Figure 11-9. Replacement Analysis

Applies to: Old New Machine Machine $2,000 $400 $1,200 40% 10% 2 45% $900 $400 $500 0 Sales revenues Operating costs except depreciation Depreciation Total operating costs Operating income Taxes 40% After-tax operating income Add back depreciation Net cash flows before replacement $0 0 -$2,000 $400 $280

Part I. Inputs:
Cost of new machine After-tax salvage value old machine Sales revenues (fixed) Annual operating costs except depreciation Tax rate WACC Depreciation 1 Depr. rates (new machine) 33% Depreciation on new machine $660 Depreciation on old machine $400 : Change in depreciation $260

Both Machines

$2,500

3 15% $300 $400 -$100 1 $2,500 1,200 400 $1,600 $900 360 $540 400 $940 1

4 7% $140 $400 -$260 2 $2,500 1,200 400 $1,600 $900 360 $540 400 $940 2

Totals: 100% $2,000 $1,600 $400 3 $2,500 1,200 400 $1,600 $900 360 $540 400 $940 3

Part II. Net Cash Flows Before Replacement: Old Machine

Part III. Net Cash Flows After Replacement: New Machine

New machine cost: After-tax salvage value, old machine Sales revenues Operating costs except depreciation Depreciation Total operating costs Operating income Taxes 40% After-tax operating income Add back depreciation Net cash flows after replacement

$2,500 280 660 $940 $1,560 624 $936 660 -$1,600 -$1,600 $308.51 $1,596 $656 IRR =

$2,500 280 900 $1,180 $1,320 528 $792 900 $1,692 $752 19.33%

$2,500 280 300 $580 $1,920 768 $1,152 300 $1,452 $512 MIRR =

Part IV. Incremental CF: Row 51 - Row 38 Part V. Evaluation

NPV =

Part VI. Alternative Calculation for Net Cash Flows

New machine cost Salvage value, old machine -$2,000 400

Net cost of new machine Other operating cost savings = Old New A-T savings = Other cost savings (1 Tax rate) Depreciation = (New Old) Depr'n tax savings = Depreciation Tax rate NCF = A-T cost savings + Depr'n tax savings

-$1,600
$920 $920 $920

552
260

552
500

552
-100

104 -$1,600 $656

200 $752

-40 $512

The Net Cash Flow time line is the sum of the larger, boldfaced, boxed, red numbers. The cash flows on Row 64 are IDENTICAL to those on Row 53.

4 $2,500 1,200 400 $1,600 $900 360 $540 400 $940 4

$2,500 280 140 $420 $2,080 832 $1,248 140 $1,388 $448 14.96%

$920

552
-260

-104 $448

s. The cash flows on

10/19/2010

Section 11.10 Decision Trees

Tab 5 extends the scenario analysis (shown in Tab 3) to incorporate the possibility of abandoning the project if demand is low. We also provide an introduction to real options. For convenience, we repeat the scenario analysis before addressing abandonment.

See Tab 3 for details concerning the scenario analysis. Figure 11-5 (Repeated from Tab 3) Inputs and Key Results for Each Scenario (Dollars in Thousands)

Scenarios:
Inputs: Probability of Scenario
Equipment cost Salvage value, equipment, Year 4 Opportunity cost Externalities (cannibalization) Units sold, Year 1 Annual change in units sold, after Year 1 Sales price per unit, Year 1 Annual change in sales price, after Year 1 Variable cost per unit (VC), Year 1 Annual change in VC, after Year 1 Nonvariable cost (Non-VC), Year 1 Annual change in Non-VC, after Year 1 Project WACC Tax rate Working capital as % of next year's sales

Base
50% $3,400
$300 $0 $0

Worst
25% $4,250
$300 $0 $0

Best
25% $2,550
$300 $0 $0

550 4.00% $11.60

2.00%

412 -6.00% $8.70

2.00%

688 14.00% $14.50

2.00%

$6.00
2.00%

$7.50
2.00%

$4.50
2.00%

$2,000
2.00% 10.00%

$2,500
2.00% 10.00%

$1,500
2.00% 10.00%

40.00%
12.65%

50.00%
12.65%

30.00%
12.65%

Key Results:
NPV IRR MIRR PI Payback Discounted payback

Base
$36 10.35% 10.23% 1.01 3.41 3.98

Worst
-$5,847 Not found -100.00% -0.24 Not found Not found

Best
$13,379 112.01% 60.30% 4.51 1.00 1.09

Analysis for Base-Case Scenario shown in blue box below. Base

Variables Used in the Cash Flow Forecast Unit sales Sales price per unit Variable cost per unit Nonvariable costs (excluding depreciation) 0 2 3 550 572 595 $11.60 $11.83 $12.07 $6.00 $6.12 $6.24 $2,000 $2,040 $2,081 Cash Flows At End of Year 1 4 619 $12.31 $6.37 $2,122

Investment Outlays at Time = 0

Equipment Initial investment in working capital Opportunity cost, after taxes

0 -$3,400 -807 0

Net Cash Flows Over the Project's Life

Sales revenues = Units Price/unit Variable costs = Units Cost/unit Nonvariable costs (excluding depreciation) Depreciation: Accelerated, from table below Operating profit (EBIT) Taxes on operating profit Net operating profit after taxes Add back depreciation Opportunity cost, after taxes Cannibalization or complementary effects, after taxes Salvage value (taxed as ordinary income) Tax on salvage value (SV is taxed at 40%) Change in WC: Outflow () or recovery (+) $6,380 3,300 2,000 1,122 -$42 -17 -$25 1,122 0 0 $6,768 3,501 2,040 1,530 -$303 -121 -$182 1,530 0 0 $7,179 3,713 2,081 510 $875 350 $525 510 0 0 $7,616 3,939 2,122 238 $1,316 526 $790 238 0 0 300 -120 963

-49

-52

-55

Project net cash flows: Time Line

Project Evaluation
Results

-$4,207

$1,048

$1,296

$980

$2,171

NPV IRR MIRR Profitability index Payback Discounted payback

Calculations for Payback

$36 10.35% 10.23% 1.01 3.41 3.98 2 -$1,863 $1,071 -$2,183 45% $1,530 3 -$883 $736 -$1,447 15% $510 4 $1,288 $1,483 $36 7% $238

Year: 0 1 Cumulative cash flows for payback -$4,207 -$3,159 Discounted cash flows for disc. payback -$4,207 $952 Cumulative discounted cash flows -$4,207 -$3,255 Accelerated Depreciation Depreciable basis: $3,400 Rate/year 33% Dollars/year $1,122

Note: the scenario analysis below is meaningful only if the values in the input section in Cells E16:E30 are set to the original base-case.
Recall from Tab 3 that we can find the value of the project under the assumption that the project must be operated its full life. For convenience, we repeat that analysis below.

Figure 11-6 (Repeated from Tab 3).

Prob: 25%

Scenario Analysis: Cannot Abandon

4 $8,705 WACC 10.00% NPV $13,379

st Be

Predicted Cash Flows for Alternative Scenarios 0 1 2 3 -$3,812 $3,813 $4,634 $5,256

st Be
1 Base

50% 25%

-$4,207 -$4,703

$1,048 -$283

$1,296 -$64

$980 -$737

$2,171

10.00%

$36 -$5,847 $1,901 $7,049 3.71

Wo rst

-$410 10.00% Expected NPV = Standard Deviation (SD) = Coefficient of Variation (CV) = Std Dev/Expected NPV =

Now assume that the project may be terminated (abandoned) at Year 2 if the demand is low. The net after-tax cash flow from salvage, legal fees, liquidation of working capital, and all other termination cost/revenues is $500 and is shown at Year 2 for the low demand scenario. As shown in Figure 11-9, the ability to abandon a project can add significant value to its NPV.

Figure 11-10. Simple Decision Tree: Can Abandon Project in Worst-Case Scenario
Prob: 25% 50% Predicted Cash Flows for Alternative Scenarios 0 1 2 3 -$3,812 $3,813 $4,634 $5,256 -$4,207
-$4,703

Be
1

st
Base

4 $8,705 $2,171
-$410

WACC 10.00% 10.00%

NPV $13,379 $36

$1,048
-$283

$1,296
-$64

$980
-$737 2

Wo

rst

25% $0 10.00% Expected NPV = Standard Deviation (SD) = Coefficient of Variation (CV) = Std Dev/Expected NPV = $500 $0 -$4,547 $2,226 $6,706 3.01

-$4,703 -$283 If abandon, can liquidate for $500 at t = 2.

Figure 11-11. Decision Tree with Multiple Decision Points

Firm can abandon the project at t = 2 Time Periods, Cash Flows, Probabilities, and Decision Points 0
1st Invest

Prob.

1 2nd Invest

2 Prob.
45%

3rd Invest -$3,812 3 -$4,207 3 Stop

3

3 Inflow $3,813 $1,048 $0 $0

4 Inflow $4,634 $1,296 $0 $0

5 Inflow $5,256 $980 $0 $0

6 Inflow $8,705 $2,171 $0 $0

80% -$100
1

-$500

40% 15%

20%

Stop

$0

Standard Deviation Coefficient of Variation (CV) = Std Dev/Expected

Analysis for Worst and Best Scenarios in yellow and green boxes below and to the right.
Dont change any values in the yellow box below. If you want to change an input, do it in Column G to the left.

Inputs
Equipment cost Salvage value, equipment, Year 4 Opportunity cost Externalities (cannibalization) Units sold, Year 1 Annual change in units sold, after Year 1 Sales price per unit, Year 1 Annual change in sales price, after Year 1 Variable cost per unit (VC), Year 1 Annual change in VC, after Year 1 Nonvariable cost (Non-VC), Year 1 Annual change in Non-VC, after Year 1 Project WACC Tax rate Working capital as % of next year's sales

Worst-Case Scenario Worst

$4,250 $300 $0 $0 412 -6.00% $8.70 2.00% $7.50 2.00% $2,500 2.00% 10.00% 50.00% 12.65%

Key Results:
NPV IRR MIRR PI Payback Discounted payback

Worst
-$5,847 Not found -100.00% -0.24 Not found Not found

Worst-Case Scenario
Variables Used in the Cash Flow Forecast Unit sales Sales price per unit Variable cost per unit Nonvariable costs (excluding depreciation) 0 2 412 387 $8.70 $8.87 $7.50 $7.65 $2,500 $2,550 Cash Flows At End of Year 1

Investment Outlays at Time = 0

Equipment Initial investment in working capital Opportunity cost, after taxes

0 -$4,250 -453 0

Net Cash Flows Over the Project's Life

Sales revenues = Units Price/unit Variable costs = Units Cost/unit Nonvariable costs (excluding depreciation) Depreciation: Accelerated, from table below Operating profit (EBIT) Taxes on operating profit Net operating profit after taxes Add back depreciation Opportunity cost, after taxes Cannibalization or complementary effects, after taxes Salvage value (taxed as ordinary income) Tax on salvage value (SV is taxed at 40%) Change in WC: Outflow () or recovery (+) $3,584 3,090 2,500 1,403 -$3,408 -1,704 -$1,704 1,403 0 0 $3,437 2,963 2,550 1,913 -$3,988 -1,994 -$1,994 1,913 0 0

19

18

Project net cash flows: Time Line

Project Evaluation
Results

-$4,703

-$283

-$64

NPV IRR MIRR Profitability index Payback Discounted payback

Calculations for Payback

-$5,847 #NUM! -100.00% -0.24 #N/A #N/A Year: 0 -$4,703 -$4,703 -$4,703 Accelerated Depreciation Rate/year Dollars/year 1 -$4,986 -$257 -$4,961 33% $1,403 2 -$5,050 -$53 -$5,013 45% $1,913

Cumulative cash flows for payback Discounted cash flows for disc. payback Cumulative discounted cash flows Depreciable basis: $4,250

Calculating step-by-step Deviation Sqrd dev Sqrd*prob

11478 131755642 $32,938,910

Quick NPV and s

-1865 -7748

3478447 60037190

$1,739,224 $15,009,298 $49,687,432 $7,049

Variance = =

$1,901 =Expected NPV $7,049 = Standard Deviation (SD)

Calculating step-by-step Deviation Sqrd dev Sqrd*prob

$11,153 -$2,190 124,399,616 4,796,486 31,099,904 2,398,243

-$6,773

45,877,342

11,469,336 44,967,482 $6,706

Variance =

WACC = WACC =

10.0% 10.0%
Calculating step-by-step Deviation
$255 -3694 -$3,593

WACC = 10.0% Product: NPV NPV Joint Prob x Joint Prob $10,503 -$525 -$555 -$100 36% 32% 12% 20% $3,781 -$168 -$67 -$20 $3,526 $2,908 0.82

Sqrd dev
64782 13649041 12909858

Sqrd*prob $23,321 4367693.004 $1,549,183

-3546

12577547 Sum = variance Sq root of Var =

2515509 8455707 $2,908

Expected NPV =

Standard Deviation (SD) = n (CV) = Std Dev/Expected NPV =

Dont change any values in the green box below. If you want to change an input, do it in Column I to the left.

Inputs

Best-Case Scenario Best

$2,550 $300 $0 $0 688 14.00% $14.50 2.00% $4.50 2.00% $1,500 2.00% 10.00% 30.00% 12.65%

Equipment cost Salvage value, equipment, Year 4 Opportunity cost Externalities (cannibalization) Units sold, Year 1 Annual change in units sold, after Year 1 Sales price per unit, Year 1 Annual change in sales price, after Year 1 Variable cost per unit (VC), Year 1 Annual change in VC, after Year 1 Nonvariable cost (Non-VC), Year 1 Annual change in Non-VC, after Year 1 Project WACC Tax rate Working capital as % of next year's sales

Key Results:
NPV IRR MIRR PI Payback Discounted payback

Best
$13,379 112.01% 60.30% 4.51 1.00 1.09

Best-Case Scenario
3 364 $9.05 $7.80 $2,601 4 342 $9.23 $7.96 $2,653 Variables Used in the Cash Flow Forecast Unit sales Sales price per unit Variable cost per unit Nonvariable costs (excluding depreciation) 0 1

s At End of Year

688 $14.50 $4.50 $1,500 Cash Flows At End of Year

Investment Outlays at Time = 0

Equipment Initial investment in working capital Opportunity cost, after taxes

0 -$2,550 -1,262 0

Net Cash Flows Over the Project's Life

$3,295 2,841 2,601 638 -$2,784 -1,392 -$1,392 638 0 0 $3,159 2,724 2,653 298 -$2,515 -1,257 -$1,257 298 0 0 300 -150 400 Sales revenues = Units Price/unit Variable costs = Units Cost/unit Nonvariable costs (excluding depreciation) Depreciation: Accelerated, from table below Operating profit (EBIT) Taxes on operating profit Net operating profit after taxes Add back depreciation Opportunity cost, after taxes Cannibalization or complementary effects, after taxes Salvage value (taxed as ordinary income) Tax on salvage value (SV is taxed at 40%) Change in WC: Outflow () or recovery (+) $9,976 3,096 1,500 842 $4,539 1,362 $3,177 842 0 0

17

-205

-$737

-$410

Project net cash flows: Time Line

Project Evaluation
Results

-$3,812

$3,813

NPV IRR MIRR Profitability index Payback Discounted payback 3 -$5,787 -$554 -$5,567 15% $638 4 -$6,198 -$280 -$5,847 7% $298
Calculations for Payback

$13,379 112.01% 60.30% 4.51 1.00 1.09

Year: 0 1 Cumulative cash flows for payback -$3,812 $1 Discounted cash flows for disc. payback -$3,812 $3,466 Cumulative discounted cash flows -$3,812 -$346 Accelerated Depreciation Depreciable basis: $2,550 Rate/year 33% Dollars/year $842

the left.

nario

nario
3 784 894 $14.79 $15.09 $4.59 $4.68 $1,530 $1,561 Cash Flows At End of Year 2 4 1,019 $15.39 $4.78 $1,592

$11,600 3,600 1,530 1,148 $5,323 1,597 $3,726 1,148 0 0

$13,489 4,186 1,561 383 $7,359 2,208 $5,152 383 0 0

-239

-278

$15,685 4,868 1,592 179 $9,047 2,714 $6,333 179 0 0 300 -90 1,984

$4,634

$5,256

$8,705

2 $4,635 $3,830 $3,484 45% $1,148

3 $9,892 $3,949 $7,434 15% $383

4 $18,597 $5,946 $13,379 7% $179

eciation

DEPRECIATION TABLES
Depreciation percentages personal property (i.e., assets other than real estate) estate), rounded for convenience.

Class of Investment Ownership Year 1 2 3 4 5 6 7 8 9 10 11 3-Year 33% 45% 15% 7% 5-Year 20% 32% 19% 12% 11% 6% 7-Year 14% 25% 17% 13% 9% 9% 9% 4% 10-Year 10% 18% 14% 12% 9% 7% 7% 7% 7% 6% 3% 100%

Actual IRS Depreciation Percentages for Property Class of Investment Ownership Year 3-Year 1 2 3 4 5 6 7 8 9 10 11 33.33% 44.45% 14.81% 7.41%

100%

100%

100%

100.00%

MACRS for Residential Real Property Month Property Placed in Service 1 2 3 3.485% 3.182% 2.879% 3.636% 3.636% 3.636% 1.970% 2.273% 2.576% 0.000% 0.000% 0.000% 99.99% 99.99% 99.99%

Year 1 2-27 28 29

4 2.576% 3.636% 2.879% 0.000% 99.99%

5 2.273% 3.636% 3.182% 0.000% 99.99%

6 1.970% 3.636% 3.458% 0.000% 99.96%

7 1.667% 3.636% 3.636% 0.152% 99.99%

MACRS for Nonresidential Real Property Month Property Placed in Service Year 1 2 3 4 5 1 2.461% 2.247% 2.033% 1.819% 1.605% 2-39 2.564% 2.564% 2.564% 2.564% 2.564% 40 0.107% 0.321% 0.535% 0.749% 0.963% 100.00% 100.00% 100.00% 100.00% 100.00% Rounded Percentages Used in Analysis Property Life (in years): Depreciation in Year 1 (assuming half-year convention): Rounded Depreciation in Years 2-39: Depreciation in Year 40:

6 1.391% 2.564% 1.177% 100.00%

7 1.177% 2.564% 1.391% 100.00%

39 1.30% 2.60% 1.30%

10/19/2010

l IRS Depreciation Percentages for Personal Property Class of Investment 5-Year 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 7-Year 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46% 10-Year 10.00% 18.00% 14.40% 11.52% 9.22% 7.37% 6.55% 6.55% 6.56% 6.55% 3.28% 100.00%

100.00%

100.00%

8 1.364% 3.636% 3.636% 0.455% 99.99%

9 1.061% 3.636% 3.636% 0.758% 99.99%

10 0.758% 3.636% 3.636% 1.061% 99.99%

11 0.455% 3.636% 3.636% 1.364% 99.99%

12 0.152% 3.636% 3.636% 1.667% 99.99%

8 0.963% 2.564% 1.605% 100.00%

9 0.749% 2.564% 1.819% 100.00%

10 0.535% 2.564% 2.033% 100.00%

11 0.321% 2.564% 2.247% 100.00%

12 0.107% 2.564% 2.461% 100.00%

Scenario Summary
Current Values: Base-Case Scenario in Column E

Changing Cells: $E$35 Base Base $E$36 50% $E$37 $3,400 $E$38 $300 $E$39 $0 $E$40 $0 $E$41 550 $E$42 4.00% $E$43 $11.60 $E$44 2.00% $E$45 $6.00 $E$46 2.00% $E$47 $2,000 $E$48 2.00% $E$49 10.00% $E$50 40.00% $E$51 12.65% Result Cells: $E$53 $36 $E$54 10.35% $E$55 10.23% $E$56 1.01 $E$57 3.41 $E$58 3.98 Notes: Current Values column represents values of changing cells at time Scenario Summary Report was created. Changing cells for each scenario are highlighted in gray.

50% $3,400 $300 $0 $0 550 4.00% $11.60 2.00% $6.00 2.00% $2,000 2.00% 10.00% 40.00% 12.65% $36 10.35% 10.23% 1.01 3.41 3.98

Show Worst-Case in Column E

Show Best-Case in Column E

Worst 25% $4,250 $300 $0 $0 412 -6.00% $8.70 2.00% $7.50 2.00% $2,500 2.00% 10.00% 50.00% 12.65% -$5,847 Not found -100.00% -0.24 Not found Not found

Best 25% $2,550 $300 $0 $0 688 14.00% $14.50 2.00% $4.50 2.00% $1,500 2.00% 10.00% 30.00% 12.65% $13,379 112.01% 60.30% 4.51 1.00 1.09