Risk Analysis and Real Option

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Presentation transcript:

Risk Analysis and Real Option Unit 3

Sensitivity Analysis

Calculation: Revenue: No of unit sold= Market share * Size of market Annual Sales= No of unit sold * Price Cost Variable Cost= variable cost per unit * no of unit sold Total Cost = Variable cost + Fixed cost

Example:

Sensitivity The change in NPV for every unit change in sales= sensitivity = Change in NPV/ change in Sales unit If sales were to drop by X units, then NPV would drop by= sensitivity * X units dropped The change in OCF for a $1 change in variable costs is: sensitivity = Change in OCF/Change in variable cost

Scenario analysis

Financial Bep Equivalent Annual Cost = Initial investment / PVIFA Financial BEP = EAC+FC (1-tc) – Depreciation * tc [(SP –VC)* (1-tc)]

Real options-expand Expected NPV= -$12 million + $2million /.20 = - $2 million Optimistic NPV = -$12 million + $3 milliony/.20 = $3 million Pessimistic NPV = -$12 million + $1 milliony/.20 = -$7 million Expected NPV = 50% * $3 million + 50% * (-$7 million) = -$2 million Expansion of 10 location if success NPV = 50% * 10 * $3 million + 50% * (-$7 million) = $11.5 m.

The option to abandon Optimistic forecast: -$12 million + $6 million/.2 = $18 million Pessimistic forecast: -$12 million - $2 million/.2 = -$22 million Expected NPV =50% * $18 million + 50% * (-$22 million) = -$2 million If project failes then abandon after year 1 Expected NPV = 50% * $18 million + 50% * (-$12 million - $2 m/1.20) = $2.17 million

Timing option Initial cost= 18 million and will decline by $130,000 per year until it reaches $1,150,000, life= 10 years and annual cash inflow of 340000 NPV0 = –$1,800,000 + $340,000(PVIFA12%,10) = $121,075.83 NPV1 = [–$1,670,000 + $340,000(PVIFA12%,9)] / 1.12 =$126,432.97 NPV2 = [–$1,540,000 + $340,000(PVIFA12%,8)] / 1.12^2 = $118,779.91 NPV3 = [–$1,410,000 + $340,000(PVIFA12%,7)] / 1.12^3 = $100,843.05 NPV4 = [–$1,280,000 + $340,000(PVIFA12%,6)] / 1.12^4 = $74,913.91 NPV5 = [–$1,150,000 + $340,000(PVIFA12%,5)] / 1.12^5 = $42,911.04 NPV6 = [–$1,150,000 + $340,000(PVIFA12%,4)] / 1.12^6 = –$59,428.45