A B C D E F G H

5 Tab 1 contains the basic model. It calculates an expansion project's cash flows and performance
6 measures using base-case, or most likely, values for the input variables. It also includes the basic
7 analysis but with straight-line depreciation.
8
9
Tab 2 extends the basic model (shown in Tab 1) to include sensitivity analysis using Data Tables
10 (we include a brief tutorial on the use of Data Tables). Tab 2 also illustrates special cases of
11 sensitivity analysis, incuding breakeven analysis, one-way data tables with multiple outputs, and two-
12 way data tables.
13
14 Tab 3 extends the basic model (shown in Tab 1) to include scenario analysis, including the use of
15 Scenario Manager.
16
17 Tab 4 extends the basic model (shown in Tab 1) to include simulation analysis.
18
19 Tab 5 illustrates the the analysis for a proposed cost-reducing replacement investment.
20 Replacement decisions differ from expansion decisions because most of the cash flows are found by
21 subtracting the old project's cash flows from those of the new project to calculate incremental cash
22 flows for use in the analysis.
23
24 Tab 6 extends the scenario analysis in Tab 3 to examine two decision trees in which the decision is
25 made in stages. The first one simply shows the situation where the firm can abandon the project if
26 things are not working out and cash flows are negative. The second one involves a marketing study
27 and a prototype of the final product designed to learn more about demand before deciding to go into
28 full production.
29
30 Tab 7 or "App. A" provides depreciation tables as described in Appendix A of the textbook.
31
32 Tab 8 shows the Scenario Summary worksheet if Excel's Scenario Analysis tool is used in Tab 3.
33
34 ANALYSIS OF AN EXPANSION PROJECT (Section 11.2)
35
36
The model uses the "Base-Case" input values shown below to calculate the NPV and other
37 performance measures. The main model assumes that the firm uses accelerated depreciation. A
38 modified version of the model, shown in Columns J through R, shows the results if the firm elects to
39 use straight-line depreciation. This analysis demonstrates that accelerated depreciation improves
40 project profitability.
41
42 Figure 11-1. Analysis of an Expansion Project: Inputs and Key Results (Dollars in Thousand
43
44 Part 1. Inputs and Key Results
45
46 Inputs Base-Case Key Results
47 Equipment cost $3,400 NPV
48 Salvage value, equipment, Year 4 $300 IRR
49 Opportunity cost $0 MIRR
 A B C D E F G H
50 Externalities (cannibalization) $0 PI
51 Units sold, Year 1 550 Payback
52 Annual change in units sold, after Year 1 4.00% Discounted payback
53 Sales price per unit, Year 1 $11.60
54 Annual change in sales price, after Year 1 2.00%
55 Variable cost per unit (VC), Year 1 $6.00
56 Annual change in VC, after Year 1 2.00%
57 Nonvariable cost (Non-VC), Year 1 $2,000
58 Annual change in Non-VC, after Year 1 2.00%
59 Project WACC 10.00%
60 Tax rate 40.00%
61 Working capital as % of next year's sales 12.65%
62
63
64
65 If you change any of the blue values in the Input Section shown above, the model below will change
66 instantly, causing changes in NPV and other output variables. You can see the effect in the Key
Results box shown above. If you change an input value but later want to return to the base case, use
67 Scenario Manager to select the Base-Case. In Excel 2003, select Tools, Scenarios. In Excel 2007,
68 select Data, What-If-Analysis, Scenario Manager.
69
70
71
72 Figure 11-2. Analysis of a New (Expansion) Project: Cash Flows and Performance Measures
73
74
75 Part 2. Cash Flows and Performance Measures
76 Variables Used in the Cash Flow Forecast 0 1 2 3
77 Unit sales 550 572 595
78 Sales price per unit $11.60 $11.83 $12.07
79 Variable cost per unit $6.00 $6.12 $6.24
80 Nonvariable costs (excluding depreciation) $2,000 $2,040 $2,081
81 Cash Flows At End of Year
82 Investment Outlays at Time = 0 0 1 2 3
83 Equipment -$3,400
84 Initial investment in working capital -807
85 Opportunity cost, after taxes 0
86 Net Cash Flows Over the Project's Life
87 Sales revenues = Units × Price/unit $6,380 $6,768 $7,179
88 Variable costs = Units × Cost/unit 3,300 3,501 3,713
89 Nonvariable costs (excluding depreciation) 2,000 2,040 2,081
90 Depreciation: Accelerated, from table below 1,122 1,530 510
91 Operating profit (EBIT) -$42 -$303 $875
92 Taxes on operating profit -17 -121 350
93 Net operating profit after taxes -$25 -$182 $525
94 Add back depreciation 1,122 1,530 510
95 Opportunity cost, after taxes 0 0 0
96 Cannibalization or complementary effects, after taxes 0 0 0
97 Salvage value (taxed as ordinary income)
 A B C D E F G H
98 Tax on salvage value (SV is taxed at 40%)
99 Change in WC: Outflow (–) or recovery (+) -49 -52 -55
100
101 Project net cash flows: Time Line -$4,207 $1,048 $1,296 $980
102
103 Project Evaluation Accelerated Straight Line
104 Results Formulas Results
105 NPV $36 =NPV(E59,F101:I101)+E101 -$18
106 IRR 10.35% =IRR(E101:I101) 9.83%
107 MIRR 10.23% =MIRR(E101:I101,E59,E59) 9.88%
108 Profitability index 1.01 =NPV(E59,F101:I101)/(-E101) 1.00
109 Payback 3.41 =PERCENTRANK(E112:I112,0,6)*I111 3.47
110 Discounted payback 3.98 =PERCENTRANK(E114:I114,0,6)*I111 #VALUE!
111 Calculations for Payback Year: 0 1 2 3
112 Cumulative cash flows for payback -$4,207 -$3,159 -$1,863 -$883
113 Discounted cash flows for disc. payback -$4,207 $952 $1,071 $736
114 Cumulative discounted cash flows -$4,207 -$3,255 -$2,183 -$1,447
115 Accelerated Depreciation
116 Depreciable basis: $3,400 Rate/year 33% 45% 15%
117 Dollars/year $1,122 $1,530 $510
118
 I
5
ows and performance
6 the basic
so includes
7
8
ysis using9Data Tables
10 of
pecial cases
ultiple outputs,
11 and two-
12
13
14 the use of
is, including
15
16
ysis. 17
18
19 .
investment
cash flows 20are found by
21
ulate incremental cash
22
23
which the24decision is
abandon the25 project if
26
lves a marketing study
27 to go into
ore deciding
28
29
30
the textbook.
31
ool is used32in Tab 3.
33
34
35
36
PV and other
37
ted depreciation. A
ults if the 38
firm elects to
epreciation 39improves
40
41
esults (Dollars
42 in Thousands)
43
44
45
Key Results
46
47 $36
48 10.35%
49 10.23%
 I
50 1.01
51 3.41
52 3.98
53
54
55
56
57
58
59
60
61
62
63
64
odel below65will change
e effect in66the Key
n to the base case, use
67 2007,
rios. In Excel
68
69
70
71
and Performance
72 Measures (Dollars in Thousands)
73
74
75
76 4
77 619
78 $12.31
79 $6.37
80 $2,122
End of Year
81
82 4
83
84
85
86
87 $7,616
88 3,939
89 2,122
90 238
91 $1,316
92 526
93 $790
94 238
95 0
96 0
97 300
 I
98 -120
99 963
100
101 $2,171
102
103
Straight Line
104
Results
105
-$18
106
9.83%
107
9.88%
108
1.00
109
3.47
110
#VALUE!
111 4
112 $1,288
113 $1,483
114 $36
115
116 7%
117 $238
118
 A B C D E F G H
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47 $3,400
48 $300
49 $0
 A B C D E F G H
50 $0
51 550
52 4.00%
53 $11.60
54 2.00%
55 $6.00
56 2.00%
57 $2,000
58 2.00%
59 10.00%
60 40.00%
61 12.65%
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47 $3,400
48 $300
49 $0
 A B C D E F G H
50 $0
51 550
52 4.00%
53 $11.60
54 0.00%
55 $6.00
56 0.00%
57 $2,000
58 0.00%
59 10.00%
60 40.00%
61 12.65%
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 9/22/2011

Section 11.5 Sensitivity Analysis

Tab 2 extends the basic model (shown in Tab 1) to include sensitivity analysis. Tab 2 also
illustrates special cases of sensitivity analysis, incuding breakeven analysis, one-way data tables with
multiple outputs, and two-way data tables. We also include a brief tutorial for Data Tables.

For ease of reference, we repeat Figure 11-1, Analysis of an Expansion Project:

Inputs and Key Results (Dollars in Thousands)

Part 1. Inputs and Key Results

Inputs Base-Case Key Results

Equipment cost $3,400 NPV $36
Salvage value, equipment, Year 4 $300 IRR 10.35%
Opportunity cost $0 MIRR 10.23%
Externalities (cannibalization) $0 PI 1.01
Units sold, Year 1 550 Payback 3.41
Annual change in units sold, after Year 1 4.00% Discounted payback 3.98
Sales price per unit, Year 1 $11.60
Annual change in sales price, after Year 1 2.00%
Variable cost per unit (VC), Year 1 $6.00
Annual change in VC, after Year 1 2.00%
Nonvariable cost (Non-VC), Year 1 $2,000
Annual change in Non-VC, after Year 1 2.00%
Project WACC 10.00%
Tax rate 40.00%
Working capital as % of next year's sales 12.65%

If you change any of the blue values above, the model below will change instantly, causing changes in
NPV and other output variables. You can see the effect in the Key Results box shown above. If you
change an input value but later want to return to the base case, use Scenario Manager to select the
Base-Case. In Excel 2003, select Tools, Scenarios. In Excel 2007, select Data, What-If-Analysis,
Scenario Manager.

For ease of reference, we repeat Figure 11-2. Analysis of a New (Expansion) Project:
Cash Flows and Performance Measures (Dollars in Thousands)

Part 2. Cash Flows and Performance Measures

Variables Used in the Cash Flow Forecast 0 1 2 3 4
Unit sales 550 572 595 619
Sales price per unit $11.60 $11.83 $12.07 $12.31
Variable cost per unit $6.00 $6.12 $6.24 $6.37
Nonvariable costs (excluding depreciation) $2,000 $2,040 $2,081 $2,122
Cash Flows At End of Year
Investment Outlays at Time = 0 0 1 2 3 4
Equipment -$3,400
Initial investment in working capital -807
Opportunity cost, after taxes 0
Net Cash Flows Over the Project's Life
Sales revenues = Units × Price/unit $6,380 $6,768 $7,179 $7,616
Variable costs = Units × Cost/unit 3,300 3,501 3,713 3,939
Nonvariable costs (excluding depreciation) 2,000 2,040 2,081 2,122
Depreciation: Accelerated, from table below 1,122 1,530 510 238
Operating profit (EBIT) -$42 -$303 $875 $1,316
Taxes on operating profit -17 -121 350 526
Net operating profit after taxes -$25 -$182 $525 $790
Add back depreciation 1,122 1,530 510 238
Opportunity cost, after taxes 0 0 0 0
Cannibalization or complementary effects, after taxes 0 0 0 0
Salvage value (taxed as ordinary income) 300
Tax on salvage value (SV is taxed at 40%) -120
Change in WC: Outflow (–) or recovery (+) -49 -52 -55 963

Project net cash flows: Time Line -$4,207 $1,048 $1,296 $980 $2,171

Project Evaluation
Results
NPV $36
IRR 10.35%
MIRR 10.23%
Profitability index 1.01
Payback 3.41
Discounted payback 3.98
Calculations for Payback Year: 0 1 2 3 4
Cumulative cash flows for payback -$4,207 -$3,159 -$1,863 -$883 $1,288
Discounted cash flows for disc. payback -$4,207 $952 $1,071 $736 $1,483
Cumulative discounted cash flows -$4,207 -$3,255 -$2,183 -$1,447 $36
Accelerated Depreciation
Depreciable basis: $3,400 Rate/year 33% 45% 15% 7%
Dollars/year $1,122 $1,530 $510 $238

SENSITIVITY ANALYSIS (Section 11.5)

Risk in capital budgeting really means the probability that the actual outcome will be worse than the
expected outcome. For example, if there were a high probability that the expected NPV as calculated
above will actually turn out to be negative, then the project would be classified as relatively risky. The
reason for a worse-than-expected outcome is, typically, because sales were lower than expected,
costs were higher than expected, or the project turned out to have a higher than expected initial cost.
In other words, if the assumed inputs turn out to be worse than expected, then the output will likewise
be worse than expected. We use data tables below to examine the project's sensitivity to changes in
the input variables.
Risk in capital budgeting really means the probability that the actual outcome will be worse than the
expected outcome. For example, if there were a high probability that the expected NPV as calculated
above will actually turn out to be negative, then the project would be classified as relatively risky. The
reason for a worse-than-expected outcome is, typically, because sales were lower than expected,
costs were higher than expected, or the project turned out to have a higher than expected initial cost.
In other words, if the assumed inputs turn out to be worse than expected, then the output will likewise
be worse than expected. We use data tables below to examine the project's sensitivity to changes in
the input variables.

Following is a tutorial for constructing a Data Table to be used in sensitivity analysis. This
section may be skipped if you already know how to construct data tables.

Instructions for Constructing Data Tables:

Step 1:

Deviation Sales NPV

Set up the Data Table by typing in the labels and numbers shown
from Base Price/unit here. The column for sales price/unit is the input range and the
-30% column for NPV is the output range. Data Tables take each input
0% $11.60 value and then automatically calculate a new output based on the
input. Be sure to type in the actual sales price of $11.60 and not a
30% formula. Every year we have students who make this mistake!
Don't be one of them!
Step 2:

Deviation Sales NPV Enter the formula =$B$117*(1+A116) into the light green cell and
then copy it into the light blue cell. This sets up the input range's
from Base Price/unit
values of sales prices for which you want new NPV's to be
-30% $8.12 calculated. It is ok to have a formula in the input range, but be sure
0% $11.60 that none of these inputs is a formula that refers back to the actual
value of sales in the input section of the worksheet.
30% $15.08

Step 3:

Deviation Sales NPV Enter into the tan cell a formula that refers to the cell in the
results section which shows the NPV for the given set of inputs. In
from Base Price/unit $35.84
this example, that is =$I$15. Notice that the tan cell will show the
-30% $8.12 current value of NPV.
0% $11.60
30% $15.08

Deviation Sales NPV Now use your cursor to hightlight the range we show in gray (this
is called the Data Table range); notice that this highlighted range
from Base Price/unit $35.84
includes the cells for the new inputs for price and the cell for the
-30% $8.12 reference to NPV.
0% $11.60
30% $15.08

With the range still highlighted, open the Table dialog

box. In Excel 2003, you go the Main Menu, select Data,
then Table. In Excel 2007, select Data, What-If-
Analysis, then Data Table.
 With the range still highlighted, open the Table dialog
box. In Excel 2003, you go the Main Menu, select Data,
then Table. In Excel 2007, select Data, What-If-
Analysis, then Data Table.

This next step is a bit tricky, so be careful. The cursor in the dialog box will be blinking in the "Row
input cell:" box. Here you have to tell Excel if the inputs in your Data Table are arranged in a row or a
column. Excel assumes a row, but this is not correct in our example--your inputs are in a column,
Column B. So, you click on the "Column input cell" box, causing the cursor to blink in that box.

Excel wants to know where the input variable, sales price, first enters the model. If you look up in the
Input Data section, you will see that it enters in cell E21, so you type E21 in the Column input cell (or
click on cell E21 to enter it). Here's the final, completed, dialog box:

When you click OK, Excel will calculate NPV at the three input values specified in your Data Table,
insert them in the table, leaving the Data Table as shown below.

Deviation Price NPV

from Base $35.84
-30% $8.12 -$3,838.74
0% $11.60 $35.84
30% $15.08 $3,910.42

We used Data Tables to create inputs for the sensitivity graph. (First, be sure the Base-Case scenario
is showing.) Note that the portion of the rows that are in the Data Tables are shown in shaded colors.

Deviation NPV Deviation NPV Deviation Sales

NPV
from Base Equipment $36 from Base Unit Sales $36 from Base Price/unit $36
-30% $2,380 $716 -30% 385 -$1,791 -30% $8.12 -$3,839
0% 3,400 36 0% 550 36 0% 11.60 36
30% 4,420 -645 30% 715 1,863 30% 15.08 3,910

Deviation NPV Deviation NPV Deviation NPV

Project
from Base VC/Unit $36 from Base Non-VC $36 from Base WACC $36
-30% $4.20 $2,083 -30% $1,400 $1,209 -30% 7.00% $361
 0% 6.00 36 0% 2,000 36 0% 10.00% 36
30% 7.80 -2,011 30% 2,600 -1,137 30% 13.00% -254

The following graph is meaningful only if the scenario is set to the Base-
Case.
Figure 11-3. Sensitivity Graph for Solar Water Heater Project
(Dollars in Thousands)

NPV
($)
$6,000

$4,000 Price

Units
$2,000

$0 WACC
Equipment
Non-VC
VC/Unit
-$2,000

-$4,000

-$6,000
-45% -30% -15% 0% 15% 30% 45%
% Deviation from Base

Data for Sensitivity Graph

Deviation NPV with Variables at Different Deviations from Base

from Base Equipment Price Units VC/Unit Non-VC WACC
-30% $716 -$3,839 -$1,791 $2,083 $1,209 $361
0% $36 $36 $36 $36 $36 $36
30% -$645 $3,910 $1,863 -$2,011 -$1,137 -$254
Range $1,361 $7,749 $3,655 $4,095 $2,346 $615

Tornado Diagrams
Tornado diagrams are another way to present results from sensitivity analysis. The first step is to rank
the range of possible NPV's for each of the input variables that is being changed. In our example, the
range for sales price/unit is the largest and the range for WACC is the smallest. The ranges for each
variable are then plotted, with the largest range on top and the smallest range on the bottom. It is
helpful to also plot a vertical line showing the base-case NPV. We present a tornado diagram in Figure
11-4. Notice that the diagram is like a tornado in that it is widest at the top and smallest at the bottom,
hence its name. The tornado diagram makes it immediately obvious which inputs have the biggest
impact on NPV.

Additional data for Tornado Diagram

Scratch for Tornado

Rank of Range of NPV from Sensitivity Table Above Diagram Below
Equipment Price Units VC/Unit Non-VC WACC Base NPV = Y-axis
Rank 2 6 4 5 3 1 $36 8
2 6 4 5 3 1 36 6
For diagram
below 2 6 4 5 3 1 36 1

Figure 11-4. Tornado Diagram for Solar Water Heater Project:

Range of Outcomes for Input Deviations from Base-Case (Dollars
in Thousands)

NPV
-$6,000 -$4,000 -$2,000 $0 $2,000 $4,000 $6,000

1 Base NPV =

Price

VC/Unit

Units

Non-VC

Equipment

WACC

NPV Breakeven Analysis

In breakeven analysis, we find the value of the input variable that produes a zero NPV. It is
easiest to do this with Goal Seek. For example, the screen shot below shows the Goal
Seek inputs we used to set the cell for NPV to a value of zero by changing the cell for the
sales price. We repeated this for the other inputs.

Table 11-1. NPV Breakeven Analysis (Dollars in Thousands)

Input Input Value that Produces Zero NPV

Sales price per unit, Year 1 $11.57
Variable cost per unit (VC), Year 1 $6.03
Annual change in units sold, after Year 1 3.58%
Units sold, Year 1 547
Nonvariable cost (Non-VC), Year 1 $2,018
Project WACC 10.35%

Data Tables: Multiple Outputs for a Single Input

Data tables can easily be extended to show multiple outputs for a single input. Simply add
an additional column with a cell reference to the desired additional output. Highlight the
specified values for the input and highlight all the columns for the output as we show
shaded in gray below (be sure to also highlight the cell references above the outputs).
Then use the Data, Tables, and set "Column input" to the cell refernce of the desired input.

Example: NPV and IRR for Changes in Sales Price

% Deviation SALES PRICE

from Sales NPV IRR
Base Case Price $36 10.4%
-30% $8.12 -$3,839 Not found
-15% $9.86 -$1,901 -11.3%
0% $11.60 $36 10.4%
15% $13.34 $1,973 27.8%
30% $15.08 $3,910 42.8%

Two-Way Data Tables: Two Inputs and One Output

Data tables can also be extended to show the output given two inputs. Put one set of input
variables in the left-most column of the data table (shown in a red font below) and the
other set of inputs in the top row of the data table (shown in white font); put the cell
reference to the output you want (like NPV) in the intersection of the row and column for
inputs (we show this in a pale green font). Highlight the range that includes the specified
values for the inputs, as shown in the gray shaded region below (this will also highlight
the cell reference for the output). Then use the Data, Tables, and set "Row input" to the
cell reference for the inputs shown in the table's row E19 for units sold) and set "Column
input" to the cell refernce for the input shown in the table's column E21 for sales price).

Example: NPV for Changes in Sales Price and Units Sold

% Deviation from Base Case

-30% -15% 0% 15% 30%
%
Deviation NPV cell
from reference Units Sold
Base Case $36 385 468 550 633 715
-30% $8.12 -$4,504 -$4,171 -$3,839 -$3,506 -$3,174
Sales Price

-15% $9.86 -$3,148 -$2,525 -$1,901 -$1,278 -$655

0% $11.60 -$1,791 -$878 $36 $949 $1,863
15% $13.34 -$435 $769 $1,973 $3,177 $4,382
30% $15.08 $921 $2,416 $3,910 $5,405 $6,900
1 2
3 4
 Scenario analysis extends risk analysis in two ways: (1) It allows us to change more than one variable
at a time, hence to see the combined effects of changes in several variables on NPV, and (2) It allows
us to bring in the probabilities of changes in the key variables.

Figure 11.6 (shown below) presents the cash flows for each scenario (the cash flows are obtained from
the 3 scenarios' analsyes conducted above in the blue, bright yellow, and green boxes). It also shows
the NPV for each scenario. Using the NPV and probability for each scenario, we calculate the expected
NPV, the standard deviation, and the coefficient of variation. Later in the analysis we consider the
possibility of abandoning the project if the worst case occurs, but our present analysis assumes that
we cannot abandon the project.

Note: the scenario analysis below is meaningful only if the values in the input section in Cells
E37:E51 are set to the original base-case.

Figure 11-6. Scenario Analysis: Expected NPV and Its Risk (Dollars in Thousands)

Predicted Cash Flows for Alternative Scenarios Calculating σ

Prob: 0 1 2 3 4 WACC NPV Deviation
st
25% -$3,812 $3,813 $4,634 $5,256 $8,705 10.00% $13,379 11478
Be
1 Base 50% -$4,207 $1,048 $1,296 $980 $2,171 10.00% $36 -1865
Wo
rst
25% -$4,703 -$283 -$64 -$737 -$410 10.00% -$5,847 -7748
Expected NPV = $1,901
Standard Deviation (SD) = $7,049
Coefficient of Variation (CV) = Std. Dev./Expected NPV = 3.71

Probability Distribution of Scenarios:

Outcomes and Probabilities

50%

25% 25%

NPV
2 2 2
Worst-Case Most-Likely Best-Case

2
Expected NPV

Scenario Manager
Rather than have 3 sets of analyses, it is possible to have only one set and use the Excel feature called
Scenario Manager. (To open the Scenario Manager dialog box in Excel 2003, select Tools, Scenarios;
in Excel 2007, select Data, What-if-Analysis, then Scenarios.) If you open the Scenario Manager dialog
box, you see the box shown below:

You can select a scenario, click "Show", and the values for that scenario will be substituted into the
input cells in Column E (E35:E51). So if we had not repeated the analysis in Columns K through AC,
Scenario Manager makes it easy to show any set of inputs in a single model for analysis. Scenario
Manager also makes it easy to create a summary of all scenarios using the Summary feature in the
dialog box shown above. For example, if you select Summary, you will see the box below:

We selected the cells with key results, E53:E58. When you click OK, the output of the summary will be
created in a new worksheet; this new worksheet is "8. Scenario Summary". It provides the same key
results as the three separate analyses did, but you need only to create one analysis with multiple sets
of inputs saved as scenarios. We encourgage you to explore the Scenaro Manager feature in our Excel
Tutorial.
Figure 11-6. Scenario Analysis: Can Abandon
 Predicted Cash Flows for Alternative Scenarios Calculating σ
Prob: 0 1 2 3 4 WACC NPV Deviation
25% -$3,812 $3,813 $4,634 $5,256 $8,705 10.00% $13,379 $11,153
st
Be
1 Base 50% -$4,207 $1,048 $1,296 $980 $2,171 10.00% $36 -$2,190

Wo -$4,703 -$283 -$64 -$737 -$410

rst
25%
-$4,703 -$283 $500 2 $0 $0 10.00% -$4,547 -$6,773
If abandon, can liquidate for $500 at t = 2. Expected NPV = $2,226
Standard Deviation (SD) = $6,706
Coefficient of Variation (CV) = Std. Dev./Expected NPV = 3.01

Figure 11-7. Decision Tree with Multiple Decision Points

 Section 11.7 Scenario Analysis

Note: this section is relatively technical and some instructors may choose to skip it with no loss in continu
Monte Carlo simulation is similar to scenario analysis in that different values of key inputs are used. Unlike scenario
analysis, Monte Carlo simulation draws a trial set of input values from specified probability distributions and then
computes the NPV for this trial. This process is repeated for hundreds, or even thousands, of trials, with key results (
NPV) saved from each trial. After running the number of desired trials, the NPVs from the trials can be averaged to
estimate the project's expected NPV; the trial results can also be used to provide a histogram showing the project's
possible outcomes.

Panel A, shown in the blue-bordered box below and slightly to the right, shows the inputs from the previous scenario
analysis. It also shows the expected value and standard deviation for those inputs based on the probability of each
scenario. To compare apples and apples, we will assume that the inputs for the simulation analysis are drawn from a
normal distribution with the same expected value and standard deviation as the inputs from the scenario analysis (the
are shown Figure 11-7 in blue in Columns C and D below. However, any of the the blue values in Columns C and D ma
changed by the user if desired. Cell D53 also has the input for the assumed correlation between units sold in Year 1 a
changes in units sold in later years.

Fgirue 11-7, shown in the box below, also shows the trial inputs and key results. The inputs are shown in red and are
drawn from a normal distribution with the mean and standard deviation specified in Columns C and D. We do this in a
step process. Column E shows a standard normal random variable created with Excel's random number generator. Co
F transforms the standard normal random variable into a normal random variable with the desired mean and standard
deviation. To see updated values,hit the F9 key.

Figure 11-7: Inputs and Key Results for the Current Simulation Trial (Dollars in Thousands)

To change an input, change one of the blue values in Columns C or D. To see an

updated set of trial values, hit the F9 key. Inputs and key results will update for the
current trial.

Inputs for Simulation Random Variables Used

Probability in Current Simulation
Distributions Trial

Standard
Expected Standard Value used
Normal
Value of Deviation in Current
Random
Input of Input Trial
Variable
Inputs:
Equipment cost $3,400 $601 2.16 $4,697
Salvage value, equipment, Year 4 $300
Opportunity cost $0
Externalities (cannibalization) $0
Units sold, Year 1 550 98 1.09 657
Annual change in units sold, after Year 1 4.00% 7.07% 1.07 11.56%
Sales price per unit, Year 1 $11.60 $2.05 1.14 $13.93
Annual change in sales price, after Year 1 2.00%
Variable cost per unit (VC), Year 1 $6.00 $1.06 -0.62 $5.34
Annual change in VC, after Year 1 2.00%
Nonvariable cost (Non-VC), Year 1 $2,000 $354 0.01 $2,004
Annual change in Non-VC, after Year 1 2.00%
Project WACC 10.00%
Tax rate 40.00% 7.07% -0.48 36.62%
Working capital as % of next year's sales 12.65%

Assumed correlation between units sold in

Year 1 and annual change in units sold in
later years:
r = 65.00%
Key Results Based on Current
Trial
NPV $5,974
IRR 45.67%
MIRR 31.14%
PI 2.02
Payback 1.93
Discounted payback 2.24

Panel B: Project Analysis for Current Trial in Simulation

Variables Used in the Cash Flow Forecast 0 1 2
Unit sales 657 733
Sales price per unit $13.93 $14.21
Variable cost per unit $5.34 $5.45
Nonvariable costs (excluding depreciation) $2,004 $2,044
Cash Flows At End of Year
Investment Outlays at Time = 0 0 1 2
Equipment -$4,697

Initial investment in working capital -1,158

Opportunity cost, after taxes 0
Net Cash Flows Over the Project's Life
Sales revenues = Units × Price/unit $9,152 $10,414
Variable costs = Units × Cost/unit 3,510 3,994
Nonvariable costs (excluding depreciation) 2,004 2,044
Depreciation: Accelerated, from table below 1,550 2,114
Operating profit (EBIT) $2,088 $2,263
Taxes on operating profit 765 829
Net operating profit after taxes $1,323 $1,434
Add back depreciation 1,550 2,114
Opportunity cost, after taxes 0 0
Cannibalization or complementary effects, after taxes 0 0
Salvage value (taxed as ordinary income)
Tax on salvage value (SV is taxed at 40%)
Change in WC: Outflow (–) or recovery (+) -160 -182
Project net cash flows: Time Line -$5,855 $2,714 $3,366

Project Evaluation
Results
NPV $5,974
IRR 45.67%
MIRR 31.14%
Profitability index 2.02
Payback 1.93
Discounted payback 2.24
Calculations for Payback Year: 0 1 2
Cumulative cash flows for payback -$5,855 -$3,141 $225
Discounted cash flows for disc. payback -$5,855 $2,467 $2,782
Cumulative discounted cash flows -$5,855 -$3,388 -$606
Accelerated Depreciation
Depreciable basis: $4,697 Rate/year 33% 45%
Dollars/year $1,550 $2,114

How the Simulation Works

We use a Data Table to perform the simulation (the Data Table is below shaded in lavender). When the Data Table is
updated, it will insert new random variables for each of the inputs we allow to change in Figure 11-7 above, run the
analysis in Panel B above, and then save the NPV for each trial. (We also save the input variables for each trial so tha
can verify that they are behaving as we expect.) We set the first column of the Data Table (the variable to be changed
each row) to numbers from 1-100. We don't really use these numbers anywhere in the analyis, but if we tell the Data T
to treat these as the Column inputs, Excel will recalculate all items in the Data Table, including the random inputs and
resulting NPV. In other words, we "trick" Excel into doing a simulation. We tell Excel to insert each of the Column inpu
the Data Table into the cell immediately below this box. This cell isn't linked to anything else, but each time Excel upd
a row of the Data Table, all the random values will be updated.

Column input cell to "trick" Excel into updating random variables in Data Table: 1

Excel normally updates all values in a Data Table each time any cell that is related to the Data Table changes. In our c
we have random variables in the Data Table, so each time any cell in the worksheet makes a calculation, the Data Tab
updated. If the Data Table has many rows, updating it can take up to 20 or 30 seconds. This is ok when we want to up
the Table, but it is annoying to wait 30 seconds any time we make any changes in the worksheet. The "check box"
explained below helps with this annoyance.

To put random variables in the Data Table for the simulation, the box shown below must be checked; otherwise, the D
Table contains only zero's and doesn't update when the sheet makes a calculation (other than the first time you check
box or if you insert or delete rows or columns). If the box is unchecked and you check it, the check mark won't show u
until the Table is updated, so don't get impatient and click it twice. After you have checked the box, the Data Table wil
update any time you change a cell in the worksheet. So to make the Data Table update, make sure the box is checked
then hit the F9 key.
 Put a check in the box below to put
trials into the data table; otherwise, the
data table will have only zeros.
✘ 0 in data table for simulation
Must be checked to put random variable

Remember to uncheck the box above when you are through with the simulation, or the Data Table will recalculate any
you make a change in the worksheet, which will slow down all other calculations in the worksheet.

You don't need to change anything in this section. It will be updated automatically if you do a simulation. The summ
the simulation results and the histogram are based on the simulation trials n the Data Table below and are updated
automatically when you do a simulation.

Note: If results ae all zeros, go back to row 144 and "check" the box by clicking it wi
Figure 11-8 Summary of Simulation Results (Thousands of Dollars)

Number of Trials = 100

Simulated Input Variables

Annual Variable Nonvariable

change in Sales price cost per cost
Equipment Units sold, units sold, per unit, unit (VC), (Non-VC),
cost Year 1 after Year 1 Year 1 Year 1 Year 1
Average $0 0 0.0% $0.00 $0.00 $0
Standard deviation 0 0 0.0% 0.00 0.00 0
Maximum 0 0 0.0% 0.00 0.00 0
Minimum 0 0 0.0% 0.00 0.00 0
Correlation with unit sales #DIV/0!
Median
Probability of NPV > 0
Coefficient of variation

Probability

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

NPV ($)
Output of Simulation in Data Table
Annual
change in Sales price Variable cost Nonvariable
Equipment Units sold, units sold, per unit, per unit cost (Non-
Trial Number cost Year 1 after Year 1 Year 1 (VC), Year 1 VC), Year 1
0 0 0 0 0 0
1 0 0 0 0 0 0
2 0 0 0 0 0 0
3 0 0 0 0 0 0
4 0 0 0 0 0 0
5 0 0 0 0 0 0
6 0 0 0 0 0 0
7 0 0 0 0 0 0
8 0 0 0 0 0 0
9 0 0 0 0 0 0
10 0 0 0 0 0 0
11 0 0 0 0 0 0
12 0 0 0 0 0 0
13 0 0 0 0 0 0
14 0 0 0 0 0 0
15 0 0 0 0 0 0
16 0 0 0 0 0 0
17 0 0 0 0 0 0
18 0 0 0 0 0 0
19 0 0 0 0 0 0
20 0 0 0 0 0 0
21 0 0 0 0 0 0
22 0 0 0 0 0 0
23 0 0 0 0 0 0
24 0 0 0 0 0 0
25 0 0 0 0 0 0
26 0 0 0 0 0 0
27 0 0 0 0 0 0
28 0 0 0 0 0 0
29 0 0 0 0 0 0
30 0 0 0 0 0 0
31 0 0 0 0 0 0
32 0 0 0 0 0 0
33 0 0 0 0 0 0
34 0 0 0 0 0 0
35 0 0 0 0 0 0
36 0 0 0 0 0 0
37 0 0 0 0 0 0
38 0 0 0 0 0 0
39 0 0 0 0 0 0
40 0 0 0 0 0 0
41 0 0 0 0 0 0
42 0 0 0 0 0 0
43 0 0 0 0 0 0
44 0 0 0 0 0 0
45 0 0 0 0 0 0
46 0 0 0 0 0 0
47 0 0 0 0 0 0
48 0 0 0 0 0 0
49 0 0 0 0 0 0
50 0 0 0 0 0 0
51 0 0 0 0 0 0
52 0 0 0 0 0 0
53 0 0 0 0 0 0
54 0 0 0 0 0 0
55 0 0 0 0 0 0
56 0 0 0 0 0 0
57 0 0 0 0 0 0
58 0 0 0 0 0 0
59 0 0 0 0 0 0
60 0 0 0 0 0 0
61 0 0 0 0 0 0
62 0 0 0 0 0 0
63 0 0 0 0 0 0
64 0 0 0 0 0 0
65 0 0 0 0 0 0
66 0 0 0 0 0 0
67 0 0 0 0 0 0
68 0 0 0 0 0 0
69 0 0 0 0 0 0
70 0 0 0 0 0 0
71 0 0 0 0 0 0
72 0 0 0 0 0 0
73 0 0 0 0 0 0
74 0 0 0 0 0 0
75 0 0 0 0 0 0
76 0 0 0 0 0 0
77 0 0 0 0 0 0
78 0 0 0 0 0 0
79 0 0 0 0 0 0
80 0 0 0 0 0 0
 81 0 0 0 0 0 0
82 0 0 0 0 0 0
83 0 0 0 0 0 0
84 0 0 0 0 0 0
85 0 0 0 0 0 0
86 0 0 0 0 0 0
87 0 0 0 0 0 0
88 0 0 0 0 0 0
89 0 0 0 0 0 0
90 0 0 0 0 0 0
91 0 0 0 0 0 0
92 0 0 0 0 0 0
93 0 0 0 0 0 0
94 0 0 0 0 0 0
95 0 0 0 0 0 0
96 0 0 0 0 0 0
97 0 0 0 0 0 0
98 0 0 0 0 0 0
99 0 0 0 0 0 0
100 0 0 0 0 0 0
 9/22/2011

it with no loss in continuity.

s are used. Unlike scenario
ty distributions and then
s, of trials, with key results (like
trials can be averaged to
ram showing the project's

from the previous scenario

on the probability of each
n analysis are drawn from a
om the scenario analysis (these
lues in Columns C and D may be
etween units sold in Year 1 and

ts are shown in red and are

mns C and D. We do this in a 2-
andom number generator. Column
e desired mean and standard

Panel A: Values from Scenario Analysis and Their Expected

Values and Standard Deviations

Inputs from Scenario Analysis for

Comparison to Simulation

Base Worst Best Expected Standard

Probability of Scenario Value of Deviation
Input of Input
50% 25% 25%

$3,400 $4,250 $2,550 $3,400 $601

$300 $300 $300
$0 $0 $0
$0 $0 $0
550 412 688 550 98
4.00% -6.00% 14.00% 4.00% 7.07%
$11.60 $8.70 $14.50 $11.60 $2.05
2.00% 2.00% 2.00%
 $6.00 $7.50 $4.50 $6.00 $1.06
2.00% 2.00% 2.00%
$2,000 $2,500 $1,500 $2,000 $354
2.00% 2.00% 2.00%
10.00% 10.00% 10.00%
40.00% 50.00% 30.00% 40.00% 7.07%
12.65% 12.65% 12.65%

Key Results
Base Worst Best
$36 -$5,847 $13,379
10.35% Not found 112.01%
10.23% -100.00% 60.30%
1.01 -0.24 4.51
3.41 Not found 1.00
3.98 Not found 1.09

3 4
818 912
$14.49 $14.78
$5.56 $5.67
$2,085 $2,127
ws At End of Year
3 4

$11,850 $13,484
4,544 5,171
2,085 2,127
705 329
$4,516 $5,858
1,654 2,145
$2,862 $3,712
705 329
0 0
0 0
300
-110
-207 1,706
 $3,360 $5,937

3 4
$3,585 $9,522
$2,524 $4,055
$1,919 $5,974

15% 7%
$705 $329

er). When the Data Table is

Figure 11-7 above, run the
variables for each trial so that we
(the variable to be changed in
lyis, but if we tell the Data Table
uding the random inputs and the
sert each of the Column inputs in
lse, but each time Excel updates

Don't change the the red cell.

Data Table changes. In our case,

s a calculation, the Data Table is
is is ok when we want to update
ksheet. The "check box"

be checked; otherwise, the Data

than the first time you check this
the check mark won't show up
d the box, the Data Table will
ake sure the box is checked and
ata Table will recalculate any time
orksheet.

do a simulation. The summary of

ble below and are updated

box by clicking it with your cursor.

Key
Results:

Tax rate NPV

0.0% $0
0.0% $0
0.0% $0
0.0% $0

$0
0.0%
#DIV/0!
Scratch work for chart: see comments.
Count
Range bottom 0 Percent
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
0 0 0 0 0 0 0 0 $0 0 0%
$0 0 0%
NPV ($) $0 0 0%
$0 0 0%
 $0 100 100%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
$0 0 0%
Sum 100 100%

Tax rate NPV

0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
0 0
Figure 11-9. Replacement Analysis

Applies to:
Both Old New
Part I. Inputs: Machines Machine Machine
Cost of new machine $2,000
After-tax salvage value old machine $400
Sales revenues (fixed) $2,500
Annual operating costs except depreciation $1,200 $280
Tax rate 40%
WACC 10%
Depreciation 1 2 3 4 Totals:
Depr. rates (new machine) 33% 45% 15% 7% 100%
Depreciation on new machine $660 $900 $300 $140 $2,000
Depreciation on old machine $400 $400 $400 $400 $1,600
∆: Change in depreciation $260 $500 -$100 -$260 $400
Part II. Net Cash Flows Before Replacement: Old Machine
0 1 2 3
Sales revenues $2,500 $2,500 $2,500
Operating costs except depreciation 1,200 1,200 1,200
Depreciation 400 400 400
Total operating costs $1,600 $1,600 $1,600
Operating income $900 $900 $900
Taxes 40% 360 360 360
After-tax operating income $540 $540 $540
Add back depreciation 400 400 400
Net cash flows before replacement $0 $940 $940 $940
Part III. Net Cash Flows After Replacement: New Machine
0 1 2 3
New machine cost: -$2,000
After-tax salvage value, old machine $400
Sales revenues $2,500 $2,500 $2,500
Operating costs except depreciation 280 280 280
Depreciation 660 900 300
Total operating costs $940 $1,180 $580
Operating income $1,560 $1,320 $1,920
Taxes 40% 624 528 768
After-tax operating income $936 $792 $1,152
Add back depreciation 660 900 300
Net cash flows after replacement -$1,600 $1,596 $1,692 $1,452

Part IV. Incremental CF: Row 51 - Row 38 -$1,600 $656 $752 $512

Part V. Evaluation NPV = $308.51 IRR = 19.33% MIRR =

Part VI. Alternative Calculation for Net Cash Flows

New machine cost -$2,000
 Salvage value, old machine 400
Net cost of new machine -$1,600
Other operating cost savings = Old — New $920 $920 $920
A-T savings = Other cost savings × (1 — Tax rate) 552 552 552
∆ Depreciation = (New — Old) 260 500 -100
Depr'n tax savings = ∆ Depreciation × Tax rate 104 200 -40
NCF = A-T cost savings + Depr'n tax savings -$1,600 $656 $752 $512

The Net Cash Flow time line is the sum of the larger, boldfaced, boxed, red numbers. The cash flows on
Row 64 are IDENTICAL to those on Row 53.
4
$2,500
1,200
400
$1,600
$900
360
$540
400
$940

$2,500
280
140
$420
$2,080
832
$1,248
140
$1,388

$448

14.96%
 $920
552
-260
-104
$448

rs. The cash flows on

 9/22/2011

Section 11.10 Decision Trees

Tab 5 extends the scenario analysis (shown in Tab 3) to incorporate the possibility of abandoning the
project if demand is low. We also provide an introduction to real options. For convenience, we repeat
the scenario analysis before addressing abandonment.

See Tab 3 for details concerning the scenario analysis.

Figure 11-5 (Repeated from Tab 3) Inputs and Key Results for Each Scenario (Dollars
in Thousands)

Scenarios:
Inputs: Base Worst Best
Probability of Scenario 50% 25% 25%
Equipment cost $3,400 $4,250 $2,550
Salvage value, equipment, Year 4 $300 $300 $300
Opportunity cost $0 $0 $0
Externalities (cannibalization) $0 $0 $0
Units sold, Year 1 550 412 688
Annual change in units sold, after Year 1 4.00% -6.00% 14.00%
Sales price per unit, Year 1 $11.60 $8.70 $14.50
Annual change in sales price, after Year 1 2.00% 2.00% 2.00%
Variable cost per unit (VC), Year 1 $6.00 $7.50 $4.50
Annual change in VC, after Year 1 2.00% 2.00% 2.00%
Nonvariable cost (Non-VC), Year 1 $2,000 $2,500 $1,500
Annual change in Non-VC, after Year 1 2.00% 2.00% 2.00%
Project WACC 10.00% 10.00% 10.00%
Tax rate 40.00% 50.00% 30.00%
Working capital as % of next year's sales 12.65% 12.65% 12.65%
Key Results: Base Worst Best
NPV $36 -$5,847 $13,379
IRR 10.35% Not found 112.01%
MIRR 10.23% Not found 60.30%
PI 1.01 -0.24 4.51
Payback 3.41 Not found 1.00
Discounted payback 3.98 Not found 1.09

Analysis for Base-Case Scenario shown in blue box below.

Base
Variables Used in the Cash Flow Forecast 0 1 2 3 4
Unit sales 550 572 595 619
Sales price per unit $11.60 $11.83 $12.07 $12.31
Variable cost per unit $6.00 $6.12 $6.24 $6.37
Nonvariable costs (excluding depreciation) $2,000 $2,040 $2,081 $2,122
Cash Flows At End of Year
Investment Outlays at Time = 0 0 1 2 3 4
Equipment -$3,400
Initial investment in working capital -807
Opportunity cost, after taxes 0
Net Cash Flows Over the Project's Life
Sales revenues = Units × Price/unit $6,380 $6,768 $7,179 $7,616
Variable costs = Units × Cost/unit 3,300 3,501 3,713 3,939
Nonvariable costs (excluding depreciation) 2,000 2,040 2,081 2,122
Depreciation: Accelerated, from table below 1,122 1,530 510 238
Operating profit (EBIT) -$42 -$303 $875 $1,316
Taxes on operating profit -17 -121 350 526
Net operating profit after taxes -$25 -$182 $525 $790
Add back depreciation 1,122 1,530 510 238
Opportunity cost, after taxes 0 0 0 0
Cannibalization or complementary effects, after taxes 0 0 0 0
Salvage value (taxed as ordinary income) 300
Tax on salvage value (SV is taxed at 40%) -120
Change in WC: Outflow (–) or recovery (+) -49 -52 -55 963

Project net cash flows: Time Line -$4,207 $1,048 $1,296 $980 $2,171

Project Evaluation
Results
NPV $36
IRR 10.35%
MIRR 10.23%
Profitability index 1.01
Payback 3.41
Discounted payback 3.98
Calculations for Payback Year: 0 1 2 3 4
Cumulative cash flows for payback -$4,207 -$3,159 -$1,863 -$883 $1,288
Discounted cash flows for disc. payback -$4,207 $952 $1,071 $736 $1,483
Cumulative discounted cash flows -$4,207 -$3,255 -$2,183 -$1,447 $36
Accelerated Depreciation
Depreciable basis: $3,400 Rate/year 33% 45% 15% 7%
Dollars/year $1,122 $1,530 $510 $238

Note: the scenario analysis below is meaningful only if the values in the input section in Cells
E16:E30 are set to the original base-case.

Recall from Tab 3 that we can find the value of the project under the assumption that the project must
be operated its full life. For convenience, we repeat that analysis below.

Figure 11-6 (Repeated from Tab 3). Scenario Analysis: Cannot Abandon
 Predicted Cash Flows for Alternative Scenarios
Prob: 0 1 2 3 4 WACC NPV
25% -$3,812 $3,813 $4,634 $5,256 $8,705 10.00% $13,379
st
Be
1 Base 50% -$4,207 $1,048 $1,296 $980 $2,171 10.00% $36
Wo
rst
25% -$4,703 -$283 -$64 -$737 -$410 10.00% -$5,847
Expected NPV = $1,901
Standard Deviation (SD) = $7,049
Coefficient of Variation (CV) = Std Dev/Expected NPV = 3.71

Now assume that the project may be terminated (abandoned) at Year 2 if the demand is low. The net
after-tax cash flow from salvage, legal fees, liquidation of working capital, and all other termination
cost/revenues is $500 and is shown at Year 2 for the low demand scenario. As shown in Figure 11-9,
the ability to abandon a project can add significant value to its NPV.

Figure 11-10. Simple Decision Tree: Can Abandon Project in Worst-Case Scenario

Predicted Cash Flows for Alternative Scenarios

Prob: 0 1 2 3 4 WACC NPV
25% -$3,812 $3,813 $4,634 $5,256 $8,705 10.00% $13,379
st
Be
1 Base 50% -$4,207 $1,048 $1,296 $980 $2,171 10.00% $36

Wo -$4,703 -$283 -$64 -$737 -$410

rst
25%
-$4,703 -$283 $500 2 $0 $0 10.00% -$4,547
If abandon, can liquidate for $500 at t = 2. Expected NPV = $2,226
Standard Deviation (SD) = $6,706
Coefficient of Variation (CV) = Std Dev/Expected NPV = 3.01

Figure 11-11. Decision Tree with Multiple Decision Points

Firm can abandon the project at t = 2

Time Periods, Cash Flows, Probabilities, and Decision Points
0 1 2 3 4 5 6
1st Invest Prob. 2nd Invest Prob. 3rd Invest Inflow Inflow Inflow Inflow

45% -$3,812 3 $3,813 $4,634 $5,256 $8,705

80% -$500 2 40% -$4,207 3 $1,048 $1,296 $980 $2,171

-$100 1 15% Stop 3 $0 $0 $0 $0

20% Stop 2 $0 $0 $0 $0 $0
2

Standard Deviation
Coefficient of Variation (CV) = Std Dev/Expected
Analysis for Worst and Best Scenarios in yellow and green
boxes below and to the right.
Don’t change any values in the yellow box below.
If you want to change an input, do it in Column G to the left.
Worst-Case Scenario
Inputs Worst

Equipment cost $4,250

Salvage value, equipment, Year 4 $300
Opportunity cost $0
Externalities (cannibalization) $0
Units sold, Year 1 412
Annual change in units sold, after Year 1 -6.00%
Sales price per unit, Year 1 $8.70
Annual change in sales price, after Year 1 2.00%
Variable cost per unit (VC), Year 1 $7.50
Annual change in VC, after Year 1 2.00%
Nonvariable cost (Non-VC), Year 1 $2,500
Annual change in Non-VC, after Year 1 2.00%
Project WACC 10.00%
Tax rate 50.00%
Working capital as % of next year's sales 12.65%
Key Results: Worst
NPV -$5,847
IRR Not found
MIRR Not found
PI -0.24
Payback Not found
Discounted payback Not found

Worst-Case Scenario
Variables Used in the Cash Flow Forecast 0 1 2
Unit sales 412 387
Sales price per unit $8.70 $8.87
Variable cost per unit $7.50 $7.65
Nonvariable costs (excluding depreciation) $2,500 $2,550
Cash Flows At End of Year
Investment Outlays at Time = 0 0 1 2
Equipment -$4,250
Initial investment in working capital -453
Opportunity cost, after taxes 0
Net Cash Flows Over the Project's Life
Sales revenues = Units × Price/unit $3,584 $3,437
Variable costs = Units × Cost/unit 3,090 2,963
Nonvariable costs (excluding depreciation) 2,500 2,550
Depreciation: Accelerated, from table below 1,403 1,913
Operating profit (EBIT) -$3,408 -$3,988
Taxes on operating profit -1,704 -1,994
Net operating profit after taxes -$1,704 -$1,994
Add back depreciation 1,403 1,913
Opportunity cost, after taxes 0 0
Cannibalization or complementary effects, after taxes 0 0
Salvage value (taxed as ordinary income)
Tax on salvage value (SV is taxed at 40%)
Change in WC: Outflow (–) or recovery (+) 19 18

Project net cash flows: Time Line -$4,703 -$283 -$64

Project Evaluation
Results
NPV -$5,847
IRR Err:523
MIRR Err:502
Profitability index -0.24
Payback #VALUE!
Discounted payback #VALUE!
Calculations for Payback Year: 0 1 2
Cumulative cash flows for payback -$4,703 -$4,986 -$5,050
Discounted cash flows for disc. payback -$4,703 -$257 -$53
Cumulative discounted cash flows -$4,703 -$4,961 -$5,013
Accelerated Depreciation
Depreciable basis: $4,250 Rate/year 33% 45%
Dollars/year $1,403 $1,913
 Calculating σ step-by-step Quick NPV
Deviation Sqrd dev Sqrd*prob and s
11478 131755642 $32,938,910

-1865 3478447 $1,739,224

-7748 60037190 $15,009,298

Variance = $49,687,432 $1,901 =Expected NPV
σ = $7,049 $7,049 = Standard Deviation (SD)

Calculating σ step-by-step
Deviation Sqrd dev Sqrd*prob
$11,153 124,399,616 31,099,904

-$2,190 4,796,486 2,398,243

-$6,773 45,877,342 11,469,336

Variance = 44,967,482
σ = $6,706

WACC = 10.0%
WACC = 10.0%
WACC = 10.0% Product: NPV Calculating σ step-by-step
NPV Joint Prob x Joint Prob Deviation Sqrd dev Sqrd*prob

$10,503 36% $3,781 $6,976 48668922 $17,520,812

-$525 32% -$168 -4051 16413941 5252460.98569415

-$555 12% -$67 -$4,081 16654799 $1,998,576

-3526.4836911416
-$100 20% -$20 -3626 13151384 2630277
 Expected NPV = $3,526 Sum = variance 27402125
Standard Deviation (SD) = $5,235 Sq root of Var = σ $5,235
n (CV) = Std Dev/Expected NPV = 1.48
 Don’t change any values in the green box below.
If you want to change an input, do it in Column I to the left.
Best-Case Scenario
Inputs Best

Equipment cost $2,550

Salvage value, equipment, Year 4 $300
Opportunity cost $0
Externalities (cannibalization) $0
Units sold, Year 1 688
Annual change in units sold, after Year 1 14.00%
Sales price per unit, Year 1 $14.50
Annual change in sales price, after Year 1 2.00%
Variable cost per unit (VC), Year 1 $4.50
Annual change in VC, after Year 1 2.00%
Nonvariable cost (Non-VC), Year 1 $1,500
Annual change in Non-VC, after Year 1 2.00%
Project WACC 10.00%
Tax rate 30.00%
Working capital as % of next year's sales 12.65%
Key Results: Best
NPV $13,379
IRR 112.01%
MIRR 60.30%
PI 4.51
Payback 1.00
Discounted payback 1.09

Best-Case Scenario
3 4 Variables Used in the Cash Flow Forecast 0 1
364 342 Unit sales 688
$9.05 $9.23 Sales price per unit $14.50
$7.80 $7.96 Variable cost per unit $4.50
 $2,601 $2,653 Nonvariable costs (excluding depreciation) $1,500
At End of Year Cash Flows At End of Yea
3 4 Investment Outlays at Time = 0 0 1
Equipment -$2,550
Initial investment in working capital -1,262
Opportunity cost, after taxes 0
Net Cash Flows Over the Project's Life
$3,295 $3,159 Sales revenues = Units × Price/unit $9,976
2,841 2,724 Variable costs = Units × Cost/unit 3,096
2,601 2,653 Nonvariable costs (excluding depreciation) 1,500
638 298 Depreciation: Accelerated, from table below 842
-$2,784 -$2,515 Operating profit (EBIT) $4,539
-1,392 -1,257 Taxes on operating profit 1,362
-$1,392 -$1,257 Net operating profit after taxes $3,177
638 298 Add back depreciation 842
0 0 Opportunity cost, after taxes 0
0 0 Cannibalization or complementary effects, after taxes 0
300 Salvage value (taxed as ordinary income)
-150 Tax on salvage value (SV is taxed at 40%)
17 400 Change in WC: Outflow (–) or recovery (+) -205

-$737 -$410 Project net cash flows: Time Line -$3,812 $3,813

Project Evaluation
Results
NPV $13,379
IRR 112.01%
MIRR 60.30%
Profitability index 4.51
Payback 1.00
Discounted payback 1.09
3 4 Calculations for Payback Year: 0 1
-$5,787 -$6,198 Cumulative cash flows for payback -$3,812 $1
-$554 -$280 Discounted cash flows for disc. payback -$3,812 $3,466
-$5,567 -$5,847 Cumulative discounted cash flows -$3,812 -$346
Accelerated Depreciation
15% 7% Depreciable basis: $2,550 Rate/year 33%
$638 $298 Dollars/year $842
the left.
nario

nario
2 3 4
784 894 1,019
$14.79 $15.09 $15.39
$4.59 $4.68 $4.78
 $1,530 $1,561 $1,592
Cash Flows At End of Year
2 3 4

$11,600 $13,489 $15,685

3,600 4,186 4,868
1,530 1,561 1,592
1,148 383 179
$5,323 $7,359 $9,047
1,597 2,208 2,714
$3,726 $5,152 $6,333
1,148 383 179
0 0 0
0 0 0
300
-90
-239 -278 1,984

$4,634 $5,256 $8,705

2 3 4
$4,635 $9,892 $18,597
$3,830 $3,949 $5,946
$3,484 $7,434 $13,379
eciation
45% 15% 7%
$1,148 $383 $179
DEPRECIATION TABLES

Depreciation percentages personal property (i.e., assets other Actual IRS Depreciation Percentages for Pe
than real estate) estate), rounded for convenience. Property
Class of Investment Class of Investment
Ownership Ownership
Year 3-Year 5-Year 7-Year 10-Year Year 3-Year

1 33% 20% 14% 10% 1 33.33%

2 45% 32% 25% 18% 2 44.45%
3 15% 19% 17% 14% 3 14.81%
4 7% 12% 13% 12% 4 7.41%
5 11% 9% 9% 5
6 6% 9% 7% 6
7 9% 7% 7
8 4% 7% 8
9 7% 9
10 6% 10
11 3% 11
100% 100% 100% 100% 100.00%

MACRS for Residential Real Property

Month Property Placed in Service

Year 1 2 3 4 5 6 7
1 3.485% 3.182% 2.879% 2.576% 2.273% 1.970% 1.667%
2-27 3.636% 3.636% 3.636% 3.636% 3.636% 3.636% 3.636%
28 1.970% 2.273% 2.576% 2.879% 3.182% 3.458% 3.636%
29 0.000% 0.000% 0.000% 0.000% 0.000% 0.000% 0.152%
99.99% 99.99% 99.99% 99.99% 99.99% 99.96% 99.99%

MACRS for Nonresidential Real Property

Month Property Placed in Service
Year 1 2 3 4 5 6 7
1 2.461% 2.247% 2.033% 1.819% 1.605% 1.391% 1.177%
2-39 2.564% 2.564% 2.564% 2.564% 2.564% 2.564% 2.564%
40 0.107% 0.321% 0.535% 0.749% 0.963% 1.177% 1.391%
100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Rounded Percentages Used in Analysis

Property Life (in years): 39
Depreciation in Year 1 (assuming half-year convention): 1.30%
Rounded Depreciation in Years 2-39: 2.60%
Depreciation in Year 40: 1.30%
 9/22/2011

IRS Depreciation Percentages for Personal

Property
Class of Investment

5-Year 7-Year 10-Year

20.00% 14.29% 10.00%

32.00% 24.49% 18.00%
19.20% 17.49% 14.40%
11.52% 12.49% 11.52%
11.52% 8.93% 9.22%
5.76% 8.92% 7.37%
8.93% 6.55%
4.46% 6.55%
6.56%
6.55%
3.28%
100.00% 100.00% 100.00%

8 9 10 11 12
1.364% 1.061% 0.758% 0.455% 0.152%
3.636% 3.636% 3.636% 3.636% 3.636%
3.636% 3.636% 3.636% 3.636% 3.636%
0.455% 0.758% 1.061% 1.364% 1.667%
99.99% 99.99% 99.99% 99.99% 99.99%

8 9 10 11 12
0.963% 0.749% 0.535% 0.321% 0.107%
2.564% 2.564% 2.564% 2.564% 2.564%
1.605% 1.819% 2.033% 2.247% 2.461%
100.00% 100.00% 100.00% 100.00% 100.00%
Scenario Summary
Current Values: Base-Case Scenario in Column E
Changing Cells:
$E$35 Base Base
$E$36 50% 50%
$E$37 $3,400 $3,400
$E$38 $300 $300
$E$39 $0 $0
$E$40 $0 $0
$E$41 550 550
$E$42 4.00% 4.00%
$E$43 $11.60 $11.60
$E$44 2.00% 2.00%
$E$45 $6.00 $6.00
$E$46 2.00% 2.00%
$E$47 $2,000 $2,000
$E$48 2.00% 2.00%
$E$49 10.00% 10.00%
$E$50 40.00% 40.00%
$E$51 12.65% 12.65%
Result Cells:
$E$53 $36 $36
$E$54 10.35% 10.35%
$E$55 10.23% 10.23%
$E$56 1.01 1.01
$E$57 3.41 3.41
$E$58 3.98 3.98
Notes: Current Values column represents values of changing cells at
time Scenario Summary Report was created. Changing cells for each
scenario are highlighted in gray.
 Show Worst-Case in Column E Show Best-Case in Column E

Worst Best
25% 25%
$4,250 $2,550
$300 $300
$0 $0
$0 $0
412 688
-6.00% 14.00%
$8.70 $14.50
2.00% 2.00%
$7.50 $4.50
2.00% 2.00%
$2,500 $1,500
2.00% 2.00%
10.00% 10.00%
50.00% 30.00%
12.65% 12.65%

-$5,847 $13,379
Not found 112.01%
-100.00% 60.30%
-0.24 4.51
Not found 1.00
Not found 1.09