Simulation

Sample Model
2005-2007 Copyright.
Dr. Johnathan Mun.
All Rights Reserved.

Discounted Cash Flow, Return on Investment and

Volatility Estimates
This sample model illustrates how to use Risk Simulator for:
1. Running a Monte Carlo simulation in a financial ROI analysis
2. Incorporating various correlations among variables (time-series and cross-sectional relationships)
3. Calculating forward-looking Volatility based on the PV Asset approach
Model Background
File Name: DCF, ROI and Volatility.xls
This is a generic discounted cash flow (DCF) model showing the net present value (NPV), internal rate of return (IRR), and return on investment (ROI)
calculations. This model can be adapted to any industry and is used to illustrate how a Monte Carlo simulation can be applied to actual investment
decisions and capital budgeting. In addition, the project's or asset's volatility is also computed in this example model. Volatility is a measure of risk
and is a key input into real options analysis.
Procedure
To run this model, simply click on Simulation l Run Simulation. However, if you wish you can create your own simulation model:
1. Start a new simulation profile and add various assumptions on the price and quantity inputs.
2. Remember to add correlations between the different years' of price and quantity (autocorrelation).
3. Continue to add correlations between price and quantity (cross-correlations).
4. Add forecasts to the key outputs (NPV and Intermediate X Variable to obtain the project's volatility).
Results Interpretation
If you run the existing simulation profile, you will obtain two forecast charts, the NPV and Intermediate X forecasts.
A. From the NPV forecast chart, select Two-Tail and enter in 95 in the Certainty box and hit TAB on the keyboard. The results show that the 95%
confidence interval for the NPV falls between $2429 and $3485. If you click on the Statistics tab, the expected value or mean shows the value $2941.
Alternatively, select Left-Tail and enter in 5 in the Certainty box and hit TAB. The results indicate that the 5% worst-case scenario will still yield a
positive NPV of $2488, indicating that this is a good project. You can now compare this with other comparable projects to decide which project should
be chosen. Finally, because probabilities of left and right tails in the same forecast distribution are complementary, if you select Right-Tail and enter
2.5 in the Certainty box and hit TAB, the result is $3485, identical to the 95% confidence level's right tail value (95% confidence interval means there
is a 2.5% probability in each tail.

Copyright 2005-2007. Real Options Valuation, Inc. (www.realoptionsvaluation.com)

B. The Intermediate X Variable is used to compute the project's volatility. See Dr. Johnathan Mun's "Modeling Risk," (Wiley 2006) for details on computing
volatility of projects using 4 different methods. To obtain a volatility measure, first modify the model as appropriate and then click on Set Static CF in the
model (near cell B46) to generate a static cash flow. Then, run the simulation and view the Intermediate Variable X's forecast chart. Go to the Statistics
tab and obtain the Standard Deviation and annualize it by multiplying the value with the square root of the number of periods per year (in this case, the
annualized volatility is 6.45% as the periodicity is annual, otherwise multiply the standard deviation by square root of 4 if quarterly data is used, or square
root of 12 if monthly data is used, and so forth).

Disclaimer
DEVELOPER SPECIFICALLY DISCLAIMS ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES
OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. As standard practice for software development and end-user applications, it is important for
the Licensee to note that the valuation results attached herein are accurate to the software Developers best knowledge and are solely based on the information furnished
by the Licensee or end-user. While the software Developer has used his best efforts in preparing this report, he makes no representations or warranties with respect to
the accuracy or completeness of the contents of this model and specifically disclaims any implied warranties of merchantability of fitness for a particular purpose. The
Licensee hereby agrees that the Developer is not held liable for any loss of profit or any other commercial damages, including, but not limited to, special, incidental,
consequential or other damages. This model is only an illustration of using the software and in no way represents the correct and complete picture of an investor's
investment, risk, and return profile. The user is advised to take great care in using and interpreting the model and its results.

Copyright 2005-2007. Real Options Valuation, Inc. (www.realoptionsvaluation.com)

Discounted Cash Flow Model

Base Year
Start Year
Market Risk-Adjusted Discount Rate
Private-Risk Discount Rate
Terminal Period Growth Rate
Effective Tax Rate

Product A Avg Price/Unit

Product B Avg Price/Unit
Product C Avg Price/Unit
Product A Sale Quantity ('000s)
Product B Sale Quantity ('000s)
Product C Sale Quantity ('000s)

Total Revenues
Direct Cost of Goods Sold

Gross Profit
Operating Expenses
Sales, General and Admin. Costs

Operating Income (EBITDA)

Depreciation
Amortization

EBIT
Interest Payments

EBT
Taxes

Net Income
Noncash: Depreciation Amortization

Noncash: Change in Net Working Capital

Noncash: Capital Expenditures
Free Cash Flow
Investment Outlay
Net Free Cash Flow
Financial Analysis
Present Value of Free Cash Flow
Present Value of Investment Outlay
Discounted Payback Period
Risk Analysis
Base Case PV at Time 0
PV of Cash Flow at Time 1
Intermediate X Variable

2005
2005
15.00%
5.00%
2.00%
40.00%

Sum PV Net Benefits

Sum PV Investments
Net Present Value
Internal Rate of Return
Return on Investment
Profitability Index

$4,481.91
$1,634.22
$2,847.69
54.64%
174.25%
2.74

Discount Type
Discrete 1End-of-Year Discounting
Discrete End-of-Year Discounting
Model Discrete Mid Include Terminal
2 Exclude Valuation
Terminal Valuation
Continuous End-of-Year Include Terminal Valuation
Continuous Midyear Discounting

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

$10.00
$12.25
$15.15
50
35
20
$1,231.75
$184.76
$1,046.99
$157.50
$15.75
$873.74
$10.00
$3.00
$860.74
$2.00
$858.74
$343.50
$515.24
$13.00
$0.00
$0.00
$528.24

$10.50
$12.50
$15.30
50
35
20
$1,268.50
$190.28
$1,078.23
$157.50
$15.75
$904.98
$10.00
$3.00
$891.98
$2.00
$889.98
$355.99
$533.99
$13.00
$0.00
$0.00
$546.99

$11.00
$12.75
$15.45
50
35
20
$1,305.25
$195.79
$1,109.46
$157.50
$15.75
$936.21
$10.00
$3.00
$923.21
$2.00
$921.21
$368.49
$552.73
$13.00
$0.00
$0.00
$565.73

$11.50
$13.00
$15.60
50
35
20
$1,342.00
$201.30
$1,140.70
$157.50
$15.75
$967.45
$10.00
$3.00
$954.45
$2.00
$952.45
$380.98
$571.47
$13.00
$0.00
$0.00
$584.47

$12.00
$13.25
$15.75
50
35
20
$1,378.75
$206.81
$1,171.94
$157.50
$15.75
$998.69
$10.00
$3.00
$985.69
$2.00
$983.69
$393.48
$590.21
$13.00
$0.00
$0.00
$603.21

$12.00
$13.25
$15.75
50
35
20
$1,378.75
$206.81
$1,171.94
$157.50
$15.75
$998.69
$10.00
$3.00
$985.69
$3.00
$982.69
$393.08
$589.61
$13.00
$0.00
$0.00
$602.61

$12.00
$13.25
$15.75
50
35
20
$1,378.75
$206.81
$1,171.94
$157.50
$15.75
$998.69
$10.00
$3.00
$985.69
$4.00
$981.69
$392.68
$589.01
$13.00
$0.00
$0.00
$602.01

$12.00
$13.25
$15.75
50
35
20
$1,378.75
$206.81
$1,171.94
$157.50
$15.75
$998.69
$10.00
$3.00
$985.69
$5.00
$980.69
$392.28
$588.41
$13.00
$0.00
$0.00
$601.41

$12.00
$13.25
$15.75
50
35
20
$1,378.75
$206.81
$1,171.94
$157.50
$15.75
$998.69
$10.00
$3.00
$985.69
$6.00
$979.69
$391.88
$587.81
$13.00
$0.00
$0.00
$600.81

$12.00
$13.25
$15.75
50
35
20
$1,378.75
$206.81
$1,171.94
$157.50
$15.75
$998.69
$10.00
$3.00
$985.69
$7.00
$978.69
$391.48
$587.21
$13.00
$0.00
$0.00
$4,709.36

$500.00
($1,105.97)

$1,500.00
$546.99

$565.73

$584.47

$603.21

$602.61

$602.01

$601.41

$600.81

$4,709.36

$528.24
$500.00
3.47 Years

$475.64
$0.00

$427.77
$1,134.22

$384.30
$0.00
3.47

$344.89
$0.00
5.53

$299.60
$0.00
7.76

$260.27
$0.00
10.17

$226.09
$0.00
12.81

$196.41
$0.00
15.68

$1,338.69
$0.00
11.13

$528.24

$475.64
$546.99

$427.77
$491.94

$384.30
$441.94

$344.89
$396.62

$299.60
$344.55

$260.27
$299.31

$226.09
$260.01

$196.41
$225.87

$1,338.69
$1,539.50

0.0144

Copyright 2005-2007. Real Options Valuation, Inc. (www.realoptionsvaluation.com)