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What is forecasting risk?
The possibility that we will make bad decisions based on the projected cash flow. Bc of the forecasting risk we will think that the project has a positive NPV when it really does not.
What are sources of value?
- 1. project cost
- 2. unit sales
- 3. prices
- 4. variable cost
- 5. fixed cost
Scenario analysis is?
The determination of what happens to NPV estimates when we ask what-if questions. These are performed to assess the degree of forecasting risk & to identify the most critical components of the success or failure of an investment.
Possible scenarios are:
- a) base case - most likely outcome
- b) best case - high revenues, low cost
- c) worst case - low revenues, high cost
To calculate Net Income:
- Sales 480,000 -
- VC 360,000-
- FC 50,000-
- Depr. 40,000
- EBIT 30,000-
- Tax 10,200
- NI 19,800
What is sensitivity analysis?
investigation of what happens to NPV when only one variable is changed.
If our NPV estimate turns out to be very sensitive to relatively small changes in the projected value of some component of project cash flow...
...then the forecastin risk associated with that variable is high.
Simulation analysis is?
A combination of scenarion & sensitivity analysis.
Variable cost changes with the?
quantity of output
Formula for VC is?
- VC=Q x v
- total quantity of output x cost per unit of output
Total cost equals to...
Cost to produce an additional unit of output. Marginal cost is the same as variable cost per unit.
The accounting break-even point is?
The sales level that results in 0 Net Income. We don't include tax; when our revenues are 0 there is no profit to tax (we do include depreciation).
Values in accounting break-even formula:
- P - selling price per unit
- v - variable cost /unit
- Q - total units sold
- S - total sales (P x Q)
- VC - total variable cost (v x Q)
- FC - fixed cost
- D - depreciation
- T - tax rate
Accounting break even formula is:
- QactgBE = FC+D / P-v
- Acctg. break-even occurs when NI is 0 and OCF is equal to D
- * when calculating D, divide investment by the number of years it takes for it to depreciate.
The general break-even expression:
- Q= FC+OCF / P-v
- where OCF= (S-VC-FC)
The cash break-even point formula is:
- QcashBE= FC(+0) / P-v
- A project that breaks even on a cash-basis occurs when OCF is 0 and never pays back.
The financial break-even point formula:
- QfinBE=FC=OCF / P-v
- it occurs when the NPV of project is 0, discounted payback is equal to project's life.
What is capital rationing?
Exists when we have positive NPV, but can't find necessary financing.
business units are alocated a certain amount of money each year for capital spending. It is a mean of controlling and keeping track of overall spending.
occurs when business cna't raise financing for a project under any circumstances.