Professional Documents
Culture Documents
CHAPTER 14
Cash Flow Estimation and Risk
Analysis
Proposed Project
0 1 2 3 4
Initial OCF1 OCF2 OCF3 OCF4
Outlay + Terminal
CF
NCF0 NCF1 NCF2 NCF3 NCF4
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Equipment ($200)
Freight + Inst. (40)
Change in NWC (20)
Net CF0 ($260)
Depreciation Basics
Basis = Cost
+ Shipping
+ Installation
$240,000
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Year 1
Net revenue $125
Depreciation (79)
Before-tax income $ 46
Taxes (40%) (18)
Net income $ 28
Depreciation 79
Net operating CF $107
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Year 1 Year 4
Net revenue $125 $125
Depreciation (79) (17)
Before-tax income $ 46 $108
Taxes (40%) (18) (43)
Net income $ 28 $ 65
Depreciation 79 17
Net operating CF $107 $ 82
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0 1 2 3 4
0 1 2 3 4
Calculator Solution
MIRR = 17.8%.
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0 1 2 3 4
Cumulative:
(260) (153) (35) 54 171
Stand-alone risk
Corporate risk
Market (or beta) risk
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Probability Density
Flatter distribution,
larger , larger
stand-alone risk.
0 E(NPV) NPV
Such graphics are increasingly used
by corporations.
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2. Corporate Risk:
Reflects the project’s effect on
corporate earnings stability.
Considers firm’s other assets
(diversification within firm).
Depends on:
project’s , and
its correlation with returns on
firm’s other assets.
Measured by the project’s
corporate beta.
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Profitability
Project X
Total Firm
Rest of Firm
0 Years
1. Project X is negatively correlated to
firm’s other assets.
2. If r < 1.0, some diversification benefits.
3. If r = 1.0, no diversification effects.
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3. Market Risk:
Reflects the project’s effect on a
well-diversified stock portfolio.
Takes account of stockholders’
other assets.
Depends on project’s and
correlation with the stock market.
Measured by the project’s market
beta.
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Illustration
Change from Resulting NPV (000s)
Base Level Unit Sales Salvage k
82 Salvage
Yes.
High correlation increases
market risk (beta).
Low correlation lowers it.
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Probability Density
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0 E(NPV) NPV
Also gives NPV, CVNPV, probability
of NPV > 0.
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