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    Scenario Analysis

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    Dickson Wong
    The tennis racket manufacturer is considering using a new graphite-like material in its rackets. It modeled three scenarios (pessimistic, expected, optimistic) based on market size, share, price, costs. It calculated revenue, costs, profits, cash flows for each scenario. It then used these figures to calculate the net present value (NPV) of each scenario using a 13% discount rate over 6 years. The NPV was negative for the pessimistic scenario but positive for the expected and optimistic scenarios. Based on the analysis, the financial analyst recommends the company accept the project.

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    Scenario Analysis

    Uploaded by

    Dickson Wong
    82 views2 pages
    The tennis racket manufacturer is considering using a new graphite-like material in its rackets. It modeled three scenarios (pessimistic, expected, optimistic) based on market size, share, price, costs. It calculated revenue, costs, profits, cash flows for each scenario. It then used these figures to calculate the net present value (NPV) of each scenario using a 13% discount rate over 6 years. The NPV was negative for the pessimistic scenario but positive for the expected and optimistic scenarios. Based on the analysis, the financial analyst recommends the company accept the project.

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    The tennis racket manufacturer is considering using a new graphite-like material in its rackets. It modeled three scenarios (pessimistic, expected, optimistic) based on market size, share, price, costs. It calculated revenue, costs, profits, cash flows for each scenario. It then used these figures to calculate the net present value (NPV) of each scenario using a 13% discount rate over 6 years. The NPV was negative for the pessimistic scenario but positive for the expected and optimistic scenarios. Based on the analysis, the financial analyst recommends the company accept the project.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    82 views2 pages

    Scenario Analysis

    Uploaded by

    Dickson Wong
    The tennis racket manufacturer is considering using a new graphite-like material in its rackets. It modeled three scenarios (pessimistic, expected, optimistic) based on market size, share, price, costs. It calculated revenue, costs, profits, cash flows for each scenario. It then used these figures to calculate the net present value (NPV) of each scenario using a 13% discount rate over 6 years. The NPV was negative for the pessimistic scenario but positive for the expected and optimistic scenarios. Based on the analysis, the financial analyst recommends the company accept the project.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 2

    Scenario Analysis

    You are the financial analyst for a tennis racket manufacturer. The company is considering using
    a graphitelike in its tennis rackets. The company has estimated the information in the following
    table about the market for a racket with the new material. The company expects to sell the racket
    for six years. The equipment required for the project will be depreciated on a straight-line basis
    and no salvage value. The required return for projects of this type is 13% percent and the company
    has a 21% tax rate. Should you recommend the project?

    Pessimistic Expected Optimistic


    Market Size 110,000 120,000 132,000
    Market Share 20% 23% 25%
    Selling Price $ 139 $ 143 $ 147
    Variable Cost Per $ 77 $ 73 $ 70
    unit
    Fixed cost per year $ 975,000 $ 920,000 $ 890,000
    Initial Investment $ 2,300,000 $ 2,150,000 $ 1,950,000

    To calculate the unit sales for each scenario, we multiply the market sales times the company’s
    market share. We can then use the quantity sold to find the revenue each year, and the variable
    costs each year. After doing these calculations, we will construct the pro forma income statement
    for each scenario. We can then find the operating cash flow using the bottom up approach, which
    is net income plus depreciation. Doing so, we find:

    Pessimistic Expected Optimistic


    Units per year 22,000 27,600 33,000

    Revenue $3,058,000.00 $3,946,800.00 $4,851,000.00


    Variable costs 1,694,000.00 2,014,800.00 2,310,000.00
    Fixed costs 975,000.00 920,000.00 890,000.00
    Depreciation 383,333.33 358,333.33 325,000.00
    EBT $5,666.67 $653,666.67 $1,326,000.00
    Tax 1,190.00 137,270.00 278,460.00
    Net income $4,476.67 $516,396.67 $1,047,540.00
    OCF $387,810.00 $874,730.00 $1,372,540.00

    Now we can calculate the NPV under each scenario, which will be:

    NPVPessimistic = –$2,300,000 + $387,810(PVIFA13%,6)


    NPV = –$749,710.22

    NPVExpected = –$2,150,000 + $874,730(PVIFA13%,6)


    NPV = $1,346,776.73

    NPVOptimistic = –$1,950,000 + $1,372,540(PVIFA13%,6)


    NPV = $3,536,796.99

    The NPV under the pessimistic scenario is negative, but the company should probably accept the
    project.

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