RISK ANALYSIS, REAL

OPTIONS AND
CAPITAL BUDGETING
Group 1:-
Anusua Dutta (19PGDM011)
Divyesh Patel (19PGDM019)
Mansi Mahajan(19PGDM026)
Navodit Sharma(19PGDM029)
Sushmita(19PGDM053)
WHAT DO SENSITIVITY,
SCENARIO, AND BREAK EVEN
ANALYSIS DO?
 Sensitivity analysis, scenario analysis
and break even analysis allows us to look
behind the NPV number to see how
stable our estimates are.
 SENSITIVITY ANALYSIS
 It examines how sensitive a particular NPV
calculation is to changes in the underlying
assumptions.
 Its advantages are:
 It improves understanding of possibilities
 It shows where more information is needed
 Its disadvantages are:
 It can increase false sense of security of managers
 It treats each variable in isolation
 BREAK-EVEN ANALYSIS
 Break-even analysis is a common tool for
analysing the relationship between sales
volume and profitability
Accounting break-even is a sales volume at
which the Net Income =0
Cash break-even is a sales volume at which
the operating cash flow = 0
Financial break-even is a sales volume at
which NPV = 0
MONTE CARLO SIMULATION
 It is a further attempt to model real-world
uncertainty and analysis the projects the way
one might evaluate gambling strategies
 It is a step beyond sensitivity and scenario
analysis for capital budgeting projects
 Interactions between the variables are explicitly
specified in the Monte Carlo Simulation –
methodology provides a more complete analysis
 But its complexity usually makes any executives
skeptical
MONTE CARLO SIMULATION
STEPS
1) Specifying the basic model ( i.e. Defining
inputs and outputs)
2) Specifying a distribution for each variable
in the model (i.e. Assigning probabilities to
each variables)
3) One outcome is drawn by the computer,
example: NPV
4) Repeat the procedure by creating 1000
scenarios
5) Calculate NPV
 CAPITAL BUDGETING
ANALYSIS STEPS
 The steps involved in capital budgeting analysis
are:
1. Develop ideas
2. Estimation of cash flows
3. Assigning risk to project and adjusting the cost
of capital (COC)
4. Analyzing cash flows and making decisions
using NPV and IRR
5. Re-evaluation or post-audit
REAL OPTIONS – WHEN THEY
HAVE VALUE?
 Real options are the adjustments that a firm
can make after a project is accepted
 It should be considered in project valuation
 Expand – If the demand is higher than expected
 Abandon – If demand is lower than expected
 Delay – If underlying variables are changing with
a favourable trend
 The market value (M) of the project can be
computed as follows:
M = NPV+Option
DECISION TREE
 A decision tree allows us to graphically
represent the alternatives available to us in
each period and the likely consequences of
our actions
THANK YOU