A project is not a black box

“What is sought is found”- Sophocles, Oedipus Tyrannus

Project analysis(or understanding what makes a

project tick)

• Sensitivity analysis

• Scenario analysis

• Break-even analysis

• Monte-Carlo analysis

• Decision Trees

Sensitivity analysis for Jalopy MotorCASH FLOW FORECASTS (millions of dollars)

Year 0 Years 1-10Investment 150Revenue 375Variable cost 300Fixed cost 30Depreciation 15Tax 15Net cash flow 30SENSITIVITY ANALYSIS

Range NPV (million $)

Pess. Exp. Opt. Pess. Exp. Opt.

Mkt size .9m. 1m. 1.1m. +11 +34 +57

Mkt share .04 .1 .16 -104 +34 +173Unit price $3500 $3750 $3800 -42 +34 +50Unit vble cost $3600 $3000 $2750 -150 +34 +111Fixed cost $m 40 30 20 +4 +34 +65

Break-even analysis for Jalopy Motor

Scooter sales, 000s Scooter sales, 000s

4000600

200

20060

2000

20085

$ million$ million

PV inflows

PV outflows

Revenues

CostsProfit = 0

NPV = 0

... in terms of present values ... in terms of accounting profit

Monte-Carlo simulation

Simulating a project:

Step 1 Step 2 Step 3

Model the Specify Select numbers for

project probabilities for forecast errors &

forecast errors calculate cash flows

Decision treesThe electric mop example

STOP STOP

STOP

Test (invest $125)

Don’t test

Success (1/2)

Failure (1/2)

Invest $1000 for full-scale production

Don’t invest

Invest $1000 for full-scale production

Don’t invest

NPV = -1000 + 250/.10 = +$1500

NPV = 0

NPV = -1000 + 75/.10 = -$250

NPV = 0