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Advance Topics in Financial Modeling

Lecture 2Kaushank Khandwala

Problem

MBD Energy is a green energy firm that wants to invest in a project having a three-year life and a terminal value that depends on the cash flow in the final quarter of the third year.

There are only two sources of uncertainty: (1) the average quarterly growth rate of revenue, and (2) variable cost as a percentage of revenue.

MBD Energy

Option 1)project manager has no flexibility to make decisions during the life of the project. That is, once the project is run to the end of three years with no expansion if successful, and noabandonment if unsuccessful.

Option 2) to abandon the project if unfavourable circumstances occur. Begin checking in the second quarter of Year 2, and abandon the project if three consecutive quarters of negative cash flow occur.