1. The McGraw-Hill Companies, Inc., 2000
Principles of Corporate Finance
Brealey and Myers Sixth Edition
A Project Is Not a Black Box
Slides by
Matthew Will
Chapter 10
Irwin/McGraw Hill
The McGraw-Hill Companies, Inc., 2000

2. Topics Covered Sensitivity Analysis Break Even Analysis
Monte Carlo Simulation
Decision Trees

3. 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

4. Sensitivity Analysis Example
Given the expected cash flow forecasts for Otoban Company’s Motor Scooter project, listed on the next slide, determine the NPV of the project given changes in the cash flow components using a 10% cost of capital. Assume that all variables remain constant, except the one you are changing. 7

5. Sensitivity Analysis
Example - continued
NPV= billion Yen 8

6. Sensitivity Analysis
Example - continued
Possible Outcomes 9

7. Sensitivity Analysis Example - continued
NPV Calculations for Pessimistic Market Size Scenario
NPV= bil yen 10

8. Sensitivity Analysis Example - continued
NPV Possibilities (Billions Yen) 11

9. Break Even Analysis Point at which the NPV=0 is the break even point.
Otoban Motors has a breakeven point of 8,000 units sold.
PV Inflows
400
200
19.6
Break even
NPV=9
PV (Yen)
Billions
PV Outflows
Sales, 000’s

10. Monte Carlo Simulation
Modeling Process
Step 1: Modeling the Project
Step 2: Specifying Probabilities
Step 3: Simulate the Cash Flows

11. Decision Trees Turboprop -550 NPV= ? or Piston -250 NPV= ? 960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
+150(.6)
+30(.4)
Turboprop
-550
NPV= ?
-150
+100(.6)
+50(.4) or
Piston
-250
NPV= ?

12. Decision Trees Turboprop -550 NPV= ? or Piston -250 NPV= ? 960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
812
456
660
364
148
+150(.6)
+30(.4)
Turboprop
-550
NPV= ?
-150
+100(.6)
+50(.4) or
Piston
-250
NPV= ?

13. Decision Trees Turboprop -550 NPV= ? or Piston -250 NPV= ? 960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
812
456
660
364
148
+150(.6)
+30(.4)
Turboprop
-550
NPV= ?
-150
+100(.6)
+50(.4) or
Piston
-250
NPV= ?

14. Decision Trees Turboprop -550 NPV= ? or Piston -250 NPV= ? 960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
812
456
660
364
148
+150(.6)
+30(.4)
Turboprop
-550
NPV= ?
*450
-150
+100(.6)
+50(.4) or
Piston
331
-250
NPV= ?

15. Decision Trees Turboprop -550 NPV= ? or Piston -250 NPV= ? 960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
NPV=888.18
812
456
660
364
148
+150(.6)
+30(.4)
Turboprop
-550
NPV= ?
NPV=444.55
*450
-150
NPV=550.00
+100(.6)
+50(.4) or
Piston
331
-250
NPV= ?
NPV=184.55

16. Decision Trees Turboprop -550 NPV= ? or Piston -250 NPV= ? 960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
NPV=888.18
812
456
660
364
148
+150(.6)
710.73
+30(.4)
Turboprop
-550
NPV= ?
NPV=444.55
*450
-150
NPV=550.00
+100(.6)
403.82
+50(.4) or
Piston
331
-250
NPV= ?
NPV=184.55

17. Decision Trees Turboprop -550 NPV=96.12 or Piston -250 NPV=117.00
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
NPV=888.18
812
456
660
364
148
+150(.6)
710.73
+30(.4)
Turboprop
-550
NPV=96.12
NPV=444.55
*450
-150
NPV=550.00
+100(.6)
403.82
+50(.4) or
Piston
331
-250
NPV=117.00
NPV=184.55

18. Decision Trees Turboprop -550 NPV=96.12 or Piston -250 NPV=117.00
960 (.8)
220(.2)
930(.4)
140(.6)
800(.8)
100(.2)
410(.8)
180(.2)
220(.4)
100(.6)
NPV=888.18
812
456
660
364
148
+150(.6)
710.73
+30(.4)
Turboprop
-550
NPV=96.12
NPV=444.55
*450
-150
NPV=550.00
+100(.6)
403.82
+50(.4) or
Piston
331
-250
NPV=117.00
NPV=184.55