FIN 614: Financial Management Larry Schrenk, Instructor

1.What is Scenario Analysis? 2.Scenario Analysis Example 3.Issues in Scenario Analysis

What happens to the NPV under different cash flows scenarios? Examines several possible situations, usually worst case, most likely case, and best case. Provides a range of possible outcomes. Excel Feature ‘Scenario Manager’

New Project Investment $1,000,000 Annual Fixed Cost $500,000 Variable Cost $10/unit Revenue$100/unit Time Horizon 3 years Initial Sales10,000 units Annual Sales Growth10% Discount Rate8% Scenario Analysis: Sales Growth Sales GrowthProbability 5%10% 60% 20%30%

Scenario Analysis: Sales Probabilities Sales GrowthProbabilityNPV 5%10%$142,650 10%60%$258,034 20%30%$499,517 Weighted NPV$318,940

Allows you to change more than one variable at a time Look at a group of scenarios (best case, base case, and worst case) for example worst case – what if all variables change against us by 20%…. Includes probability estimates of each scenario

Benefits More than one variable changes at a time Accounts for probability Easy to perform Weaknesses Small number of scenarios is unrealistic Probability distributions difficult to estimate Assumes that inputs are perfectly correlated

FIN 614: Financial Management Larry Schrenk, Instructor