Measures of Risk

NPV Probability
200 0.3
600 0.5
900 0.2
1
E(NPV) = 540
s= 250
CV = 0.46
Semi-Variance (SV) = 34680
Semi-Standard
Deviation = 186.2
 Certainty Equivalent Method
Certainty
Expected Equivalent
Year Cash Flow Coefficient
1 1,000,000 0.90
2 1,500,000 0.85
3 2,000,000 0.82
4 2,500,000 0.78

Initial Investment= 4,500,000

Risk free interest rate 5%

NPV 534,569
Sensitivity Analysis using built in features of Excel
Sensitivity analysis ('000)
Project life in years 10 NPV for various values of Investments, Sales
Discount rate 12% ('000) ('000)
Investment (20,000) Investment 2,604 Sales 2604
Variable costs as a
percentage of sales 66.67% (12,000) 10,604 12,000 (4,932)
Tax rate 33.30% (14,000) 8,604 15,000 (1,164)
Sales per year 18,000 (16,000) 6,604 18,000 2,604
Variable costs per year 12,001 (18,000) 4,604 21,000 6,373
Fixed costs per year 1,000 (20,000) 2,604 24,000 10,141
Depreciation per year 2,000 (22,000) 604 27,000 13,909
Pre-tax profit per year 2,999 (24,000) (1,396) 30,000 17,678
Taxes per year (33.33%) 999 (26,000) (3,396) 33,000 21,446
Profit after taxes per year 2,001 (28,000) (5,396) 36,000 25,214
Cash flow from operation
per year 4,001
Net present value 2,604

Discount Rate > 2,604 10% 11% 12% 13% 14% 15%
Sales > 12,000 -3614 -4295 -4932 -5530 -6090 -6616
15,000 484 -367 -1164 -1911 -2611 -3269
18,000 4582 3560 2604 1708 868 78
21,000 8680 7488 6373 5327 4346 3425
24,000 12778 11416 10141 8946 7825 6772
27,000 16876 15344 13909 12565 11304 10120
30,000 20974 19271 17678 16184 14783 13467
33,000 25072 23199 21446 19803 18262 16814
36,000 29170 27127 25214 23422 21740 20161

Once we get the value of net present value in B 16, to get the values of net present
values for various values of sales, investments etc.proceed as follows.
In column E5, copy the formula from B16 and press enter-the numerical value of
net present value will appear. Next fill in cells D6 to D14 with the various values of sales
for which you wish to have the correspondig net present values. Care should be taken
to leave the cell D5 (the cell adjacent to E5 to the left) . Then select all the cells from
D5 to E14. Go to menu item Data, click on Table. In the dialogue box that will appear
fill in the slot against Column input cell the reference number of the cell whose values
we require- in this case B16 and then click OK. All the cells from E6 to E14 will
automatically get filled with the required values. Now you can give a heading to the
sales column by typing Sales in D5.
Similarly you can proceed to get the NPVs for various investmet values
Scenario Summary
Current Values: Pessimistic Expected Optimistic Most Likely
Changing Cells:
$C$7 21,000 15,000 18,000 21,000 20,000
$C$4 (18,000) (24,000) (20,000) (18,000) (18,000)
$C$5 65.00% 70.00% 66.67% 65.00% 60.00%
$C$9 800 1,300 1,000 800 900
Result Cells:
$C$16 10,064 -7,426 2,599 10,064 12,136
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.
 Discount Rate Project Life Tax Rate
12% 10 33.33%
Expected values
Investment in year 0 (18,000)
Variable Costs as a Percentage of Sales 65.00%
For years 1 to 10
Sales 21,000
Variable Costs =C7*C5 13,650
Fixed Costs 800
Depreciation =-C4/B2 1,800
Pre-tax Profit =C7-C8-C9-C10 4,750
Taxes =C11*C2 1,583
Profit after Taxes =C11-C12 3,167
Cash Flow from Operations =C13+C10 4,967
Present Value of the Cash Flow stream =PV(A2,B2,-C14) 28,064
Net Present Value of the Project =C15+C4 10,064

Key variables Pessimistic Expected Optimistic

Investment -24,000 -20,000 -18,000
Sales 15,000 18,000 21,000
Variable Costs as a percent of sales 70 66.67 65
Fixed Costs 1,300 1,000 800

Net present values corresponding to the three scenarios can be readily obtained using Scenario
Manager in Excel. For this go to Tools and in the drop-down menu click on Scenarios. A dialogue
box called Scenario Manager appears. In that fill in the Scenario name as Pessimistic and against
Changing cells, the cell nos. C4,C7,C5,C9 and click on OK. In the new dialogue box that appears fill
in the values of C4,C7,C5 and C as -24000,15,000, 0.7 and 1300 respectively and click on OK. The
Scenario Manager reappears. Click on Add and repeat the process for the other two scenarios by
filling in the respective values. Once all the three scenarios are filled in, in the Scenario Manager
click on Scenario Summary. In the Scenario Summary dialogue box , against Result cells, type C16
and click on OK. A summary ouptput containing the NPVs of the three scenarios will appear in a
separate worksheet( in this case the summary is in the next sheet- Exhibit 11.6)
 Pessimistic

-24000
0.7

15000

1300

Page 6
 Expected

-20000
0.6667

18000

1000

Page 7
 Optimistic

-18000
0.65

21000

800

Page 8
 Most Likely

-18000
0.6

20000

900

Page 9
Scenario Summary
Current Values: Pessimistic Expected Optimistic
Changing Cells:
Sales 21,000 15,000 18,000 21,000
Investment (18,000) (24,000) (20,000) (18,000)
Variable Cost (%) 65.00% 70.00% 66.67% 65.00%
Fixed Cost 800 1,300 1,000 800
Result Cells:
NPV 10,064 -7,426 2,599 10,064
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.
Break - Even Analysis
('000)
Year 0 1 to 10
Investment (20,000)
Variable costs as a percentage of sales 66.67%
Tax rate 33.30%
Sales per year 18,000
Variable costs per year 12,001
Fixed costs per year 1,000
Depreciation per year 2,000
Pre-tax profit per year 2,999
Taxes per year (33.33%) 999
Profit after taxes per year 2,001
Cash flow from operation per year 4,001
Accounting break-even level of sales 9,001
Calculation of the financial break-even level of sales
Discount rate 12%
Project life in years 10
Total of the present values of the cash inflows 22,604
Initial investment 20,000
Financial break-even level of sales 15,926