Created 7/1/1996
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Business Administration 130:

Where Do Cash Flows Come From?





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 boxes--but a good financial manager should never accept black boxes.

Techniques for project analysis:

Sensitivity Analysis:

An electric car project:

Year 0

Years 1-10


- $150



 Variable Cost


 Fixed Cost




 Pretax Profit



- $15

 Net Profit


 Operating Cash Flow


 Net Cash Flow



Assuming that the investment is depreciated straight-line 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:





 Market size




 Market share




 Unit price




 Unit variable cost




 Fixed cost




The project is by no means a sure thing--if 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.

Break-Even Analysis

Adam Smith
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