01-10-2012, 05:34 PM
FUNDAMENTALS CORPORATE FINANCE
FUNDAMENTALS.ppt (Size: 725 KB / Downloads: 86)
Key Concepts and Skills
Understand forecasting risk and sources of value
Understand and be able to do scenario and sensitivity analysis
Understand the various forms of break-even analysis
Understand operating leverage
Understand capital rationing
Evaluating NPV Estimates
NPV estimates are just that – estimates
A positive NPV is a good start – now we need to take a closer look
Forecasting risk – how sensitive is our NPV to changes in the cash flow estimates; the more sensitive, the greater the forecasting risk
Sources of value – why does this project create value?
Scenario Analysis
What happens to the NPV under different cash flow scenarios?
At the very least look at:
Best case – high revenues, low costs
Worst case – low revenues, high costs
Measure of the range of possible outcomes
Best case and worst case are not necessarily probable, but they can still be possible
New Project Example
Consider the project discussed in the text
The initial cost is $200,000 and the project has a 5-year life. There is no salvage. Depreciation is straight-line, the required return is 12%, and the tax rate is 34%
The base case NPV is 15,567
Sensitivity Analysis
What happens to NPV when we vary one variable at a time
This is a subset of scenario analysis where we are looking at the effect of specific variables on NPV
The greater the volatility in NPV in relation to a specific variable, the larger the forecasting risk associated with that variable, and the more attention we want to pay to its estimation