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Transactions on the Built Environment vol 53, © 2001 WIT Press, www.witpress.

com, ISSN 1743-3509

Application of sensitivity analysis in shipyard investment projects
R. ~ a ~ n aG. E. , k ~ Okudanl, M . ~ u n e r "
'Department of Business Adn~inistratzon, Gebze Institute of Technology. Kocaeli - Turkey. 2~eparttnerzt Naval Architecture Engineering, of Yildiz Technical University, Istanbzil - Turkey.

Investing on shipyard and shipbuilding requires considerable amount of expenditure. This expenditure is expecteri to produce income after the completion o f the investment. In general, income is directly proportional to risk. Risk yields either a high income or a loss. Therefore, critical variables, which may have an affect on the investment outcome should be determined, and further analyzed. Sensitivity analysis is one of the tools used for this purpose. This work presents a sensitivity analysis application on inflation rate for a shipyard investment project where inflation values experienced in Turkey over two decades were used.

1 Introduction
Sensitivity analysis is one of several techniques that can be used for risk analysis. It is particularly useful when effects of various variables -such as the discount rate, the loan interest rate. the project cost and the sales volume- on the main criterion of the analysis are of interest. The sensitivity analysis is applicable to any variable that is expected to affect the outcome. However. a prioritization among the variables may be necessary when resources are scarce. Net present value (NPV) and!or internal rate of return (IRR) are generally used as criteria. N P V is the total value of differences between discounted incomes and losses of the investment. It is the current monetary value of the investment's net expected income. Discount rate is the interest rate used in calculating the present value o f expected yearly benefits and costs [ l ] . The discount rate is used to

such as the period of repayment. the proposal is accepted. © 2001 WIT Press. . the following steps are taken for assessing the risk of investment projects [3]. otherwise it is considered to be a loss [2]. and if it is lower than the minimum point. the investment is profitable. If the internal rate of return is bigger than 10%. and (t) is the investment's economic life [l]. ii.witpress. a more detailed analysis on various project criteria should be considered. www. the calculated rate of return is compared to the cost of capital. The predicted cash flow is discounted to one rate or figure. Various industry sectors have different risk levels changing based on technology. affects all projects regardless of their sector. a range is considered for the threshold. which translates expected benefits or costs in any given future year into present value terms. For investment decisions governed by the internal rate of return. i. 2 Risk assessment of investment projects In general. the proposal is rejected. Investment proposal is accepted if the calculated figure or rate is better than a threshold value. and on many criteria such as the protit rate. and drought in agricultural investments. compulsory changes in the capacity utilization and loan interest rate. Internal rate of return is the discount rate that sets the net present value of the stream of net benefits equal to The sensitivity analysis is one of the efficient tools that will help the investor decide about future outconles of the investment under risk and uncertainty. ISSN 1743-3509 obtain the discount factors. hornever. If the predicted project return is higher than the maximum point.Transactions on the Built Environment vol 53. the risk of storm and sea accidents in marine transportation. Annual cash inflows calculated by this rate will produce a total value equal to investment's current value. Generally. For any value in between. all investment projects are subject to risk inherent to their nature: for example. This rate or figure is compared to the net present value of the investment expenditures or to an acceptable rate of return. iii. competition and market conditions. The discount factor is equal to l/(l+i)' where (i) is the interest rate. and encourage or discourage investing [4]. Let's assume that the interest rate for the loan acquired for the investment is 10%. or net present value etc. Uncertainty. internal rate of return. In addition to common investment risk factors such as inflation.

for any investment project. ISSN 1743-3509 3 Use of sensitivity analysis in Turkey The sensitivity analysis has not been used adequately for investment decision analysis in Turkey. Interest rate risk Credit risk Financial risk Work force risk Market share and market flow risk Re-investment risk Technological risk Geographical & political risk Country and transfer risk Inflation risk Exchange rate risk Among risk factors mentioned above. some can be ignored. the financial analysis is not regarded as important as the social benefit [ 6 ] . particularly in Turkey. © 2001 WIT Press. Reinvestment risk is the tendency to explore other investment opportunities due to increased uncertainty. the pre-determined analysis criterion . creditors -banks in general.uses a scoring system that integrates economic and technologic efficiency of the project. While some of these factors significantly affect the result of an investment project. however. The determination of most significant risk factors of the project is the second Therefore. For this purpose.Transactions on the Built Environment vol 53. The Technology Developnient Foundation of Turkey. An example could be the loss of shipbuilding market by Western countries equipped with advanced technologies to Eastern Europe and Far-East countries because of the higher cost of labor in the West. which was established to sponsor technology projects [j]. Determining the most influential ones and analyzing them will save time: and help analysts to reach the expected result easily. State sponsored projects are evaluated based on social benefits.analyse the accounting records of the investor before any amount of investment fund is issued. the financial strength of the investor is seen very important. the investment decision is more critical due to the uncertainty and hence risks. Some also include technical analysis of the project to their process of credit evaluation. feasibility analysis and detailed risk analysis should be done. Accordingly. Therefore. www. Analyzing risk may be accomplished by sensitivity analysis in three steps: The first step is to determine risk factors affecting the project. market flow and re-investment risk ma] require explanation.witpress.for . The possible investment risks are as fo'llows [ 6 ] . For the investor. Market flow is the transfer of the market to other locations for various reasons. Mostly.

and inflation rate. a wider range of values for each significant factor are integrated to the calculations. Inflation in terms of US dollars has been forecasted based on previously experienced 10-year values for each year durmg the economic life of the investment. and prediction of cash flows for the predetermined economic life of the investment project for various capacity utilization rates.- . u o r k force and geographical risk.- - -0. F~gure Pred~cted 1 and Exper~enced lnflat~on Rates .416. and comparisons to the threshold range are done. It is acquired via bank loans and shareholder's equity equally. The total value of the investment is US$ 8. The rest of the paper demonstrates an application o f the sensitivity analysis for a boatyard investment project. Investing in boatyard has several risk factors like market flow risk.361. and exchange rate risk. © 2001 WIT Press. loan interest rate. interest rate and inflation risk. The risk factor creating the largest variation in the absolute value of NPV is the most critical risk factor o f the project [ 7 ] .Transactions on the Built Environment vol 53. extensive field study is done. The report covered location selection. USD is chosen as the currency for the analysis.4 1 -+-Pred~cted lnflat~on Rate Years +Experienced Inflation Rate .is calculated for every possible risk factor with varying levels. After the selection of factors. Figure 1 depicts predicted and experienced values of inflation in terms of US 4 Sensitivity analysis of a boatyard investment project A boatyard feasibility report has been used as the investment project on which sensitivity analysis is applied [g]. Based on the result o f facility location optimization.witpress. and econoniic life of the prqject is assumed as l I years. www. This study has included the most influential risk factors in Turkey: the capacity utilization rate. For the feasibility report. the boatyard is decided to be located at Mersin . This final step ends with invest or abandon decis~on.a southern city of Turkey on the Mediterranean coast. machinery and equipment selection. ISSN 1743-3509 example NPV. The construction period o f the investment is planned to be two years.

111 0.75 -0. © 2001 WIT Press. purchasing and selling prices are kept constant. The reason for this is twofold: First of all.089 0. and have a market niche where there is increasing competition. the planned 75% capacity utilization should be changed.75 0.246 1 ' ' I 0. production cost in boat building is mainly affected by the labor cost.75 0. Investment Life Predicted Inflation Rate Predicted Capacity Utilization Rate 1 l Real Inflation Rate l Real Capacity Utilization Rate l 1988 1989 1990 1991 1992 1993 1994 1995 l996 0.Transactions on the Built Environment vol 53.75 0.75 0. an increase in sales price may affect the sales volume.03 -0. Inflation and Capacitj I!tiiizat~on Rates Figure 2 demonstrates the adjustment level necessary while managing the capacity in terms of predicted and experienced capacity utilization rate ratio.75 0.92 0. As seen in Table 1. ISSN 1743-3509 Due to the differences in the predicted and experienced inflation rates. These necessary levels of capacity utilization are calculated for experienced values of inflation and are shown in Table 1.75 1.154 0. For this analysis.021 0.036 -0. Because they are luxury products. which is rather low in Turkey when exchange rates are accounted for. this adjusted rate may be more than loo%.76 0.78 Table 1 . this ratio has bigger values when inflation increases as for years of 1990 and 1995. which is not attainable without additional investment.01 0.75 0. which would indicate a higher capacity utilization rate. . Secondly.75 0.176 0.77 0.266 -0.281 0. When inflation is having negative values the capacity utilization rate may not be decreased for higher revenues. in order to keep the investment This ratio needs careful analysis.055 0.068 0.witpress.198 0.1 1.133 0. Therefore.224 0. and hence the capacity utilization.046 0. As can be seen in Table 1. the sales price for boats 1s kept constant.06 1. www.

Transactions on the Built Environment vol 53. he would be loosing money when inflation rate increases and the current capacity level does not permit more Let's assume that the investor has found the investment proposal profitable and decided to invest in this project. Table 3 shows this analysis.361.828. This calculation shows a net gain of 17. In this case.470 for an investment amount of 8. www. ISSN 1743-3509 Table 2 shows the NPV calculation for predicted expenses and revenues based on 75% capacity utilization rate and predicted inflation rates. he needs to further analyze how the NPV changes for various levels of differences in capacity utilisation rate. 10% less. 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Years Table 2.witpress. Therefore. Predicted Cash Flow for the Investment .416 in USD. even if he can sell whatever amount is produced. for 20% less. 1 0 % h o r e and 20% more of predicted inflation values. © 2001 WIT Press.

5 Conclusion Turkey has been experiencing high levels of inflation for the last three decades. www. it can be concluded that instability of inflation rate can have positive and negative effects. it should be remembered that the investment is not sensitive just to inflation rate increases. Ilowever.758.Transactions on the Built Environment vol 53. In Table 3. T h ~ shas affected the investors In the past. it will have effects in the future. and therefore. his actual gain has been 32. Sensitivity Analysis of the Investment for Different Inflation USD. many investors loose interest in investing. it could be seen that in U S D the inflation has been quite different than what it had been with TRL.819. Therefore. Also. .819. However. © 2001 WIT Press. The difference is more than 50%. The biggest problem with unstable inflation is that it almost makes it impossible to predict the outcome of the investment. ISSN 1743-3509 Table 3. The level of it has been as high as 150% and down to 65%. sensitivity analysis should be taken further to include other risk factors and their two-way or three-way interactions as well. Investors should utilize this information with a careful study o f risk factors using sensitivity analysis. It is much less in USD. although the investor has accepted to invest for a NPV of 17. it can be seen that changes in the inflation rate have a huge effect on the NPV for this investment. sensitivity analysis gives thorough understanding for what might happen for risk factors under study. Likewise. when values are reviewed care full^. For the case included in the study.193.193 USD for the same amount of investment. Therefore. However. it has been unstable.witpress.509 and 32.838. The values for KPV are in the range of 14.

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