Created 7/1/1996
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Basics:
Exam:
Not good at knowing when your calculator has betrayed you; little sense of what answer should be. Little sense of the relationship between variance of securities, variance of portfolios, and betas...
No Black Boxes:
A black box is something that we accept and use but do not understand. We have been treating capital porjects as black boxesbut a good financial manager should never accept black boxes.
Techniques for project analysis:
Sensitivity Analysis:
An electric car project:
Year 0 
Years 110  
Investment   $150 

Revenue  $375  
Variable Cost  $300  
Fixed Cost  $30  
Depreciation  $15  
Pretax Profit  $30  
Tax   $15  
Net Profit  $15  
Operating Cash Flow  $30  
Net Cash Flow  $150 
$30 
Assuming that the investment is depreciated straightline over ten years, and that corporate income is taxed at a rate of 50%.
With a 10% opportunity cost of capital, NPV = 150 +sum(i=1 to 10, $30/((1.10)^{t})) = +$34.3. Should you invest? The right answer is that you should make your forecasting staff do more work:
Variable 
Pessimistic 
Expected 
Optimistic 
Market size  +$11 
+$34 
+$57 
Market share  $104 
+$34 
+$173 
Unit price  $42 
$34 
+$50 
Unit variable cost  $150 
+$34 
+$111 
Fixed cost  +$4 
+$34 
+$65 
The project is by no means a sure thingif you can find information to improve your forecasts of unit variable costs and of market share, you should do so.
Limits to sensitivity analysis: what does "optimistic" mean?
What if variables are interrelated? Scenarios. Different consistent combinations.
BreakEven Analysis