CHAPTER 14 Cash Flow Estimation and Risk Analysis. Relevant cash flows Working capital treatment Inflation Risk Analysis: Sensitivity Analysis, Scenario Analysis, and Simulation Analysis. Proposed Project. Cost: $200,000 + $10,000 shipping + $30,000 installation. Depreciable cost $240,000.
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Cash Flow Estimation and Risk Analysis
= Corporate cash flow
Corporate cash flow
Suppose $100,000 had been spent last year to improve the production line site. Should this cost be included in the analysis?
Suppose the plant space could be leased out for $25,000 a year. Would this affect the analysis?
If the new product line would decrease sales of the firm’s other products by $50,000 per year, would this affect the analysis?
NWC = $25,000 - $5,000
Depreciation Basics other products by $50,000 per year, would this affect the analysis?
Basis = Cost
Annual Depreciation Expense (000s) other products by $50,000 per year, would this affect the analysis?
Year 1 Operating Cash Flows (000s) other products by $50,000 per year, would this affect the analysis?
Year 4 Operating Cash Flows (000s) other products by $50,000 per year, would this affect the analysis?
Cash flow from sale = Sale proceeds
- taxes paid.
Taxes are based on difference between sales price and tax basis, where:
Basis = Original basis - Accum. deprec.
Example: If Sold After 3 Years (000s) depreciated?
Project Net CFs on a Time Line depreciated?
Enter CFs in CFLO register and I = 10.
NPV = $81,573.
IRR = 23.8%.
What is the project’s MIRR? (000s) depreciated?
MIRR = ?
Calculator Solution depreciated?
1. Enter positive CFs in CFLO:I = 10; Solve for NPV = $341.60.
2. Use TVM keys: PV = 341.60, N = 4I = 10; PMT = 0; Solve for FV = 500.10. (TV of inflows)
3. Use TVM keys: N = 4; FV = 500.10;PV = -260; PMT= 0; Solve for I = 17.8.
MIRR = 17.8%.
What is the project’s payback? (000s) depreciated?
Payback = 2 + 35/89 = 2.4 years.
If 5% inflation is expected over the next 5 years, are the firm’s cash flow estimates accurate?
Real vs. Nominal Cash flows firm’s cash flow estimates accurate?
1. Stand-Alone Risk:
Probability Density one another?
larger , larger
Such graphics are increasingly used
2. Corporate Risk: one another?
Profitability one another?
Rest of Firm
1. Project X is negatively correlated to firm’s other assets.
2. If r < 1.0, some diversification benefits.
3. If r = 1.0, no diversification effects.
3. Market Risk: one another?
NPV one another?
-30 -20 -10 Base 10 20 30
E(NPV) = $ 82
(NPV) = 47
CV(NPV) = (NPV)/E(NPV) = 0.57
Are there any problems with scenario analysis? correlated with the general economy and thus with the “market”?
Probability Density correlated with the general economy and thus with the “market”?
x x x x
x x x x x x x x x x x x x x x x x x x x x x x x
x x x
x x x x x
x x x x
x x x x x x x x x x x x x x x x x x x x x x x x x
0 E(NPV) NPV
Also gives NPV, CVNPV, probability
of NPV > 0.