Module 3 - Project Analysis
Bonds and Boeing Example
Boeing as a case study for bond analysis.
Characteristics of Boeing's bond portfolio:
Outstanding Bonds: $70 billion.
Variety of Issues: 60 different bond issues.
The portfolio exemplifies:
Premiums.
Discounts.
Downgrades.
Long-dated vs. Short-dated bonds.
VIX (Volatility Index)
Definition:
The VIX measures the market’s expectation of volatility over the next 30 days.
Often referred to as the “fear gauge” of the stock market.
Published by the CBOE (Chicago Board Options Exchange).
Based on prices of S&P 500 index options.
What It Measures:
Reflects implied volatility, as opposed to past (historical) volatility.
A rise in option prices signals investor expectations of larger future price swings.
Converts options prices to an annualized standard deviation percentage.
Interpretation of the VIX Number:
Quoted in percentage points (e.g., VIX = 20).
Represents expected annualized volatility.
Rule of Thumb:
Expected 30-day move ≈ VIX ÷ √12
Example: If VIX = 24, then 30-day expected move ≈ 24% ÷ 3.46 ≈ 6.9%.
Indicates the market anticipates roughly a ±6.9% move in the S&P 500 over the next month (one standard deviation).
Exam Note:
Information is not material for the exam.
VIX Movement Data
Historical and current VIX movement data presented from various years spanning 1990 to 2026.
Noteworthy events correlated to VIX spikes (e.g. GFC, Covid, 9/11).
Relevant Example:
$60 ÷ 3.46 ≈ 17.3% move expected.
VIX Last 2 Years
VIX data points provided biweekly from March 2024 to the present (2025).
Example computation:
For VIX today = 21.44% → Expected 30-day move ≈ 21.44% ÷ 3.46 ≈ 6.2% move.
Project Evaluation Overview
Transitioning from evaluating single projects to addressing projects with unequal lives and multi-variable influences.
Analytical Focus Areas:
Sensitivity Analysis.
Scenario Analysis.
Reference to Chapter 11 in the textbook for deeper understanding.
Choosing Between Alternatives: Battery Example
Problem context: Selection between two types of batteries with the following parameters:
Tax Rate: 34%.
Required Rate of Return: 15%.
Depreciation Method: Straight-line depreciation to $0 value.
Inquiry on whether to run NPVs for battery selection given unequal lives.
Converting PVs to Annuities
Importance of converting Present Values into Annuities for comparison.
Benefits:
Enables an apples-to-apples comparison (dollars per year).
Avoids bias towards longer-lived projects, which may show larger total PVs.
Incorporates the time value of money adequately through the discount rate, ensuring annual values reflect financing costs.
Supports capital rationing and resource allocation decisions by revealing annual value creation metrics.
Equivalent Annual Value (EAV) and Equivalent Annual Cost (EAC)
Method to evaluate projects with dissimilar lives using EAV or EAC, based on annuity values derived from Present Value cash flows.
Steps in Capital Budgeting
Stepwise approach outlined:
Don’t Panic - Initial guidance for decision-making.
Compute Relevant Cash Flows:
Free Cash Flows (FCF) from the project.
Changes in Net Working Capital (NWC).
Capital expenditures.
Compute NPV for each project.
Convert NPV into an annuity to derive EAV/EAC.
Battery Case Study: Pur-A-Cell
Pur-A-Cell Financials:
Cost: $60.
Term: 5 years.
Annual Depreciation: $12/year.
Market Value at Sale: $5.
Structure of cash flows shown for evaluation:
Sales: 0.0 for years 0-5.
Costs: $88.0 per year.
EBIT: (100.0) consistently.
Taxes: @34% impacting cash flows.
PV Calculation: Resulted in PV = ($239.4).
Battery Case Study: NeverReady
NeverReady Financials:
Cost: $36.
Term: 3 years.
Annual Depreciation: $12/year.
Market Value at Sale: $5.
Structure of cash flows shown for evaluation:
Sales: 0.0 for years 0-3.
Costs: $100.0 per year.
EBIT: (112.0) consistently.
PV Calculation: Resulted in PV = ($175.2).
Determining Equivalent Annual Cost (EAC)
Condition of negative NPV for battery evaluation.
Calculation of EAC for both batteries:
Pur-A-Cell EAC: =PMT(15%, Term, -NPV).
Results in EAC of ($71.41).
NeverReady EAC: =PMT(15%, 3, +175.2).
Results in EAC of ($76.74).
Conclusion: Least Cost Option determined as Pur-A-Cell.
GizmoMaker Case Study
Comparison between two gizmos:
Gizmo 1:
Initial cost: $80,000.
Annual operating cost: $10,000.
Life: 4 years.
Salvage value: $5,000.
Gizmo 2:
Initial cost: $120,000.
Annual operating cost: $7,000.
Life: 7 years.
Salvage value: $10,000.
Gizmo 1 & Gizmo 2 Solutions
Detailed cash flow diagrams and calculations for both gizmos presented:
Gizmo 1 NPV Calculation:
Cash flows through 4 years; salvage adjustment made for final year.
Resulted in NPV = (108.28) and Annuity = (34.16).
Gizmo 2 NPV Calculation:
Cash flows through 7 years; salvage adjustment made similarly.
Resulted in NPV = (148.95) and Annuity = (30.59).
Conclusion drawn: Prefer Gizmo 2 as it is least costly.
Equivalent Annual Value Example
Two projects are analyzed with dissimilar lives using the following metrics:
Project A:
Initial cost: $50,000.
Annual revenue: $25,000.
Life: 3 years.
Salvage: $0.
Project B:
Initial cost: $80,000.
Annual revenue: $20,000.
Life: 5 years.
Salvage: $5,000.
Project A & B Net Present Value and Equivalent Annual Values
Cash flow PV calculations presented for both projects:
Project A:
PV and NPV results lead to highest return calculated from annualized values.
Project B:
Also calculated for EAV/EAC, but found to have less favorable outcomes.
Exam 2 Notes and Formula Sheet
Review of exam 2 notes, important equations listed:
EBIT plus Rent.
Earnings before taxes, taxes, and net income.
Capital budgeting calculations emphasized, including cash flows and terminal value considerations.
Multi-part questions explained, indicating resets for each question as independent queries.
Conclusion of Comprehensive Valuation Problem
Additional comprehensive valuation problem available for study on Canvas.
Importance of practicing with mock exams advised for preparation.
Encouragement to submit questions for clarification before class sessions.