Build A Model Chapter 11 Cash Flow Estimation And Risk Analy

Build A Modelchapter11cash Flow Estimation And Risk Analysisa Devel

Build a spreadsheet model to perform cash flow estimation and risk analysis for a proposed project. Calculate the project's Net Present Value (NPV), Internal Rate of Return (IRR), and payback period using the provided input data. Conduct sensitivity analyses to assess how changes in sales price, variable costs per unit, and units sold affect the NPV. Perform a scenario analysis with different probability-weighted outcomes. Adjust risk metrics based on the project's risk profile, and finally, evaluate whether the project should be accepted based on the analysis results.

Sample Paper For Above instruction

The objective of this paper is to develop a comprehensive financial model to evaluate a proposed project’s viability through cash flow estimation and risk assessment. Utilizing spreadsheet tools such as Excel, the goal is to calculate key financial metrics—including NPV, IRR, and payback period—by incorporating projected revenues, costs, depreciation, salvage values, and working capital changes. Additionally, it involves conducting sensitivity and scenario analyses to understand the impact of variable fluctuations and project risk, then adjusting financial metrics based on the project's risk profile, ultimately providing an informed investment decision.

To begin, a detailed cash flow model is constructed. The model integrates the provided input data: equipment costs of $25,000, net working capital as 12% of sales, initial sales volume of 2,000 units, sales price of $21 per unit, variable costs of $15 per unit, and non-variable costs of $1,500. The project spans four years, with specified depreciation rates leading to annual depreciation expenses, and includes salvage values at year 4. An assumed inflation rate of 2.5% influences future prices and costs, compelling adjustments in the model to reflect inflationary effects over time.

Development of the Cash Flow Model

The core of the model rests on calculating annual cash flows, starting with annual revenues. For each year, revenue is obtained by multiplying units sold by the sales price per unit, which is adjusted for inflation if necessary. Subtracting variable and non-variable operating costs yields operating income before depreciation (EBIT). Deducting depreciation expenses results in taxable income, which is then taxed at a 20% rate. The net operating profit after taxes (NOPAT) is computed by subtracting tax from EBIT.

Depreciation is calculated based on the provided percentages, and accumulated depreciation is deducted from equipment costs to determine book value and salvage value at project termination. Cash flows are then adjusted by adding back depreciation (a non-cash expense) and accounting for changes in net working capital (NOWC), which increases initially as part of project setup and is recovered at project end.

Financial Metrics Calculation

The NPV is calculated by discounting the annual cash flows at the project's Weighted Average Cost of Capital (WACC) of 10%. The IRR is obtained by solving for the discount rate that makes the NPV zero. The payback period is assessed by cumulatively summing cash flows until recovered, both in nominal and discounted terms for the discounted payback.

These metrics provide a baseline evaluation of the project's financial viability, with NPV indicating value creation, IRR measuring profitability, and payback reflecting liquidity and risk considerations.

Sensitivity and Scenario Analyses

To gauge the robustness of the project’s financial viability, sensitivity analyses are conducted by varying key assumptions—sales price, variable costs, and units sold—by ±10% and ±20%. For each scenario, the model recalculates NPV to identify which variables most influence project value. Such analysis pinpoints parameters that warrant careful management or further scrutiny.

Moreover, a scenario analysis incorporating probabilistic outcomes considers three states—best, base, and worst case—with assigned probabilities of 25%, 50%, and 25%. The respective scenarios adjust input assumptions: revenue increases/decreases, sales volumes, and costs. Using Excel’s Scenario Manager, the expected value of NPV, along with its standard deviation and coefficient of variation, is derived, informing on the project's risk profile under different conditions.

Risk Adjustment

Given the project's risk profile—assessed via the coefficient of variation (CV)—the analysis adjusts the financial metrics accordingly. For an average-risk project, the CV range is 0.8 to 1.2. If the project exhibits higher risk, the discount rate (WACC) is increased towards 13%, whereas for lower risk, WACC is reduced to 8%. Calculating risk-adjusted NPV and IRR involves discounting at these adjusted rates. The payback period is also reassessed under these risk scenarios.

Conclusion and Recommendation

Based on the comprehensive analysis, if the risk-adjusted NPV remains positive, and the IRR exceeds the risk-adjusted WACC, the project appears financially viable. Should sensitivity analysis reveal high vulnerability to certain variables, or scenario analysis suggest considerable risk, further caution is warranted. Conversely, if the project demonstrates resilient positive metrics across scenarios, it can be recommended for approval.

In this case, assuming the calculations show the project exceeds the hurdle rate with acceptable risk, the recommendation would be to proceed with the project investment, monitored by ongoing sensitivity and risk assessments throughout its life cycle.

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