week 7 - Capital Budgeting III: A Complete View.

Break even analysis

Where a business generates enough revenue to cover its total costs

NPV break even

At what level of each parameter would the project have a zero NPV

units sold = (sg&a + dep)/(sale price -cost per unit)

Sensitivity analysis

Capital budgeting tool that determines how the NPV varies as a single underlying assumption is changed
Find baseline NPV (price-cost)*unit sales/cost of capital - initial cost

Calculate NPV for best and worst case scenarios (lower and upper bound)

Keeping base unit price and base cost unit price the same and cost of capital as well (only thing that is different is lower and upper unit sales)

Calculate change in NPV = (lower or upper) - base divided by base → drops/rises by xx%

Scenario analysis

Capital budgeting tool that determines how the NPC varies as a number of the underlying assumptions are changed simultaneously

Same as sensitivity analysis but changing values in relation to worst and best case scenario

Same calculations

Decisions tree analysis

1.. Identify Costs and Probabilities

Initial cost (at t = 0): –$500,000

Cash inflow (if successful, from t = 2 onward): $150,000 p.a. in perpetuity

Probability of success: 33%

Probability of failure: 67%

Discount rate: 12%

2. Calculate Perpetuity Value (if successful), CF/discount rate

3. Find Expected Value at t = 1 , (rCF​)*Psuccess​+0*Pfailure​

4. Discount Expected Value to t = 0, expec value/(1+r)

5. Calculate NPV, investment + expec value/(1+r)

decision