《CorporateFinance》Chap007.pptVIP

Risk Analysis, Real Options, and Capital Budgeting Key Concepts and Skills Understand and be able to apply scenario and sensitivity analysis Understand the various forms of break-even analysis Understand Monte Carlo simulation Understand the importance of real options in capital budgeting Understand decision trees Chapter Outline 7.1 Sensitivity Analysis, Scenario Analysis, and Break-Even Analysis 7.2 Monte Carlo Simulation 7.3 Real Options 7.4 Decision Trees 7.1 Sensitivity, Scenario, and Break-Even Each allows us to look behind the NPV number to see how stable our estimates are. When working with spreadsheets, try to build your model so that you can adjust variables in a single cell and have the NPV calculations update accordingly. Example: Stewart Pharmaceuticals Stewart Pharmaceuticals Corporation is considering investing in the development of a drug that cures the common cold. A corporate planning group, including representatives from production, marketing, and engineering, has recommended that the firm go ahead with the test and development phase. This preliminary phase will last one year and cost $1 billion. Furthermore, the group believes that there is a 60% chance that tests will prove successful. If the initial tests are successful, Stewart Pharmaceuticals can go ahead with full-scale production. This investment phase will cost $1.6 billion. Production will occur over the following 4 years. NPV Following Successful Test Note that the NPV is calculated as of date 1, the date at which the investment of $1,600 million is made. Later we bring this number back to date 0. Assume a cost of capital of 10%. NPV Following Unsuccessful Test Note that the NPV is calculated as of date 1, the date at which the investment of $1,600 million is made. Later we bring this number back to date 0. Assume a cost of capital of 10%. Decision to Test Let’s move back to the first stage, where the decision boils down to the simple question: should we invest? The expected payoff eva