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11StandAloneRiskAnalysis (Compatibility Mode)

The document presents an analysis of investing in pilot production and testing of an electric moped developed by Vigyanik. There is a 70% chance the pilot will be successful, in which case Vigyanik can build a plant for Rs. 150 million that would generate Rs. 30 million annual cash flow with 60% probability or Rs. 20 million with 40% probability over 20 years. Decision tree analysis shows the optimal strategy is to carry out the pilot with an expected monetary value of Rs. 44.2 million, and only invest in the plant if the pilot is successful.

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50 views7 pages

11StandAloneRiskAnalysis (Compatibility Mode)

The document presents an analysis of investing in pilot production and testing of an electric moped developed by Vigyanik. There is a 70% chance the pilot will be successful, in which case Vigyanik can build a plant for Rs. 150 million that would generate Rs. 30 million annual cash flow with 60% probability or Rs. 20 million with 40% probability over 20 years. Decision tree analysis shows the optimal strategy is to carry out the pilot with an expected monetary value of Rs. 44.2 million, and only invest in the plant if the pilot is successful.

Uploaded by

sshreyas
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 7

Chapter 11

Stand- Alone Risk Analysis

Sensitivity Analysis
(000)
YEAR 0
1. INVESTMENT

YEARS 1 - 10

(20,000)

2. SALES

18,000

3. VARIABLE COSTS (66 2/3 % OF SALES)

12,000

4. FIXED COSTS

1,000

5. DEPRECIATION

2,000

6. PRE-TAX PROFIT

3,000

7. TAXES

1,000

8. PROFIT AFTER TAXES

2,000

9. CASH FLOW FROM OPERATION

4,000

10. NET CASH FLOW

(20,000)

4,000

NPV = -20,000,000 + 4,000,000 (5.650) = 2,600,000


RS. IN MILLION
RANGE
KEY VARIABLE

PESSIMISTIC

NPV

EXPECTED OPTIMISTIC

PESSIMISTIC

EXPECTED

OPTIMISTIC

INVESTMENT (RS. IN MILLION)

24

20

18

-0.65

2.60

4.22

SALES (RS. IN MILLION)

15

18

21

-1.17

2.60

6.40

VARIABLE COSTS AS A

70

66.66

65

0.34

2.60

3.73

1.3

1.0

1.47

2.60

3.33

PERCENT OF SALES
FIXED COSTS

0.8

Scenario Analysis
Procedure
1. Select the factor around which scenarios will be built.
2. Estimate values of each of the variables for each Scenario
3. Calculate NPV / IRR under each scenario
NET PRESENT VALUE FOR THREE SCENARIOS
(RS. IN MILLION)
SCENARIO 1
INITIAL INVESTMENT

SCENARIO 2

SCENARIO 3

200

200

200

UNIT SELLING PRICE (IN RUPEES)

25

15

40

DEMAND (IN UNITS)

20

40

10

REVENUES

500

600

400

VARIABLE COSTS

240

480

120

FIXED COSTS

50

50

50

DEPRECIATION

20

20

20

190

50

210

TAX @ 50%

95

25

105

PROFIT AFTER TAX

95

25

105

115

45

125

PRE-TAX PROFIT

ANNUAL CASH FLOW


PROJECT LIFE
SALVAGE VALUE
NET PRESENT VALUE (AT A DISCOUNT
RATE OF 15 PERCENT)

10 YEARS
0
377.2

10 YEARS

10 YEARS

25.9

427.4

Break-Even Analysis
Accounting Break Even Analysis
Fixed Costs + Depreciation

1+2
=

Contribution margin ratio

Financial Break Even Analysis


Breakeven in terms of NPV

= Rs. 9 million
0.333

Hillier Model
Uncorrelated Cash Flows (i.e. period to period)
n
Ct
NPV =
I
t = 1 (1 + i)t
(NPV) =

n
t2

t = 1 (1 + i)2t

Perfectly Correlated Cash Flows


n
NPV =
t=1

Ct
I
(1 + i) t

n
(NPV) =
t=1

t
(1 + i)t

Vigyanik case
The scientists at Vigyanik have come up with an electric
moped. The firm is ready for pilot production and test
marketing. This will cost Rs.20 million and take six months.
Management believes that there is a 70 percent chance that the
pilot production and test marketing will be successful. In case
of success, Vigyanik can build a plant costing Rs.150 million.
The plant will generate an annual cash inflow of Rs.30 million
for 20 years if the demand is high or an annual cash inflow of
Rs.20 million if the demand is moderate. High demand has a
probability of 0.6; Moderate demand has a probability of 0.4.
To analyse such situations where sequential decision making is
involved decision tree analysis is helpful.

Vigyanik Case
Based on the evaluation, optimal
decision strategy is : Choose D11 at
the decision point D1 and wait for
the outcome at the chance point C1.
If the outcome at C1 is C11
(success), invest Rs.150 million; if
the outcome at C1 is C12 (failure)
then stop
EMV = 44.2
C11 : Success
D11: Carry out pilot
production and
market test
-Rs 20
million

D1

c1

EMV = 10.9
D12:Do nothing

Probability
: 0.7

C21 : High
demand Annual
cash flow
Probability 30 million
: 0.6

EMV = 194.2
D21:Invest
-Rs 150
million

c2

D2
D22: Stop

EMV = 30.9
C12 : Failure
Probability : 0.3

D3

D31: Stop

C22 : Moderate Annual


demand
cash flow
Probability
20 million
: 0.4

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