1. Investment Decision Rules
Chapter 7
Investment Decision Rules

2. 7.1 NPV and Stand-Alone Projects
Researchers at Fredrick’s Feed and Farm have made a breakthrough.
They believe that they can produce a new, environmentally friendly fertilizer at a substantial cost savings over the company’s existing line of fertilizer.
The fertilizer will require a new plant that can be built immediately at a cost of $250 million.
Financial managers estimate that the benefits of the new fertilizer will be $35 million per year, starting at the end of the first year and lasting forever
A take-it-or-leave-it investment decision involving a single, stand- alone project

3. NPV Rule The NPV of the project is calculated as:
he financial managers responsible for this project estimate a cost of capital of 10% per year.
Using this cost of capital the NPV is $100 million, which is positive.
The NPV investment rule indicates that by making the investment, the value of the firm will increase by $100 million today, so Fredrick’s should undertake this project.

4. NPV Rule
The NPV of the project depends on the appropriate cost of capital.
Often, there may be some uncertainty regarding the project’s cost of capital.
In that case, it is helpful to compute an NPV profile: a graph of the project’s NPV over a range of discount rates.
Figure 7.1 plots the NPV of the fertilizer project as a function of the discount rate, r.
Notice that the NPV is positive only for discount rates that are less than 14%.
When r = 14%, the NPV is zero.
Recall from Chapter 4 that the internal rate of return (IRR) of an investment is the discount rate that sets the NPV of the project’s cash flows equal to zero.
Thus, the fertilizer project has an IRR of 14%.

5. Figure 7.1 NPV of Fredrick’s Fertilizer Project
If FFF’s cost of capital is 10%, the NPV is $100 million and they should undertake the investment.

6. Alternative Rules Versus the NPV Rule
The IRR of a project provides useful information regarding the sensitivity of the project’s NPV to errors in the estimate of its cost of capital.
Sometimes alternative investment rules may give the same answer as the NPV rule, but at other times they may disagree.
When the rules conflict, the NPV decision rule should be followed.

7. 7.2 The Internal Rate of Return Rule(IRR) Investment Rule
One interpretation of the internal rate of return is the average return earned by taking on the investment opportunity.
The internal rate of return (IRR) investment rule is based on this idea: If the average return on the investment opportunity (i.e., the IRR) is greater than the return on other alternatives in the market with equivalent risk and maturity (i.e., the project’s cost of capital), you should undertake the investment opportunity.
We state the rule formally as follows: IRR Investment Rule: Take any investment opportunity where the IRR exceeds the opportunity cost of capital. Turn down any opportunity whose IRR is less than the opportunity cost of capital.

8. The Internal Rate of Return Rule (cont'd)
The IRR Investment Rule will give the same answer as the NPV rule in many, but not all, situations.
In general, the IRR rule works for a stand- alone project if all of the project’s negative cash flows precede its positive cash flows.
In Figure 7.1, whenever the cost of capital is below the IRR of 14%, the project has a positive NPV and you should undertake the investment.

9. Applying The IRR Rule
In other cases, the IRR rule may disagree with the NPV rule and thus be incorrect.
Situations where the IRR rule and NPV rule may be in conflict:
Delayed Investments
Nonexistent IRR
Multiple IRRs

10. Applying The IRR Rule (cont'd)
Delayed Investments
Assume you have just retired as the CEO of a successful company.
A major publisher has offered you a book deal. The publisher will pay you $1 million upfront if you agree to write a book about your experiences.
You estimate that it will take three years to write the book.
The time you spend writing will cause you to give up speaking engagements amounting to $500,000 per year.
You estimate your opportunity cost to be 10%.

11. Applying The IRR Rule (cont'd)
Delayed Investments
Should you accept the deal?
Since the NPV is negative, the NPV rule indicates you should reject the deal.

12. Figure 7.2 NPV of Star’s $1 Million Book Deal
When the benefits of an investment occur before the costs, the NPV is an increasing function of the discount rate.

13. Applying The IRR Rule (cont'd)
For most investment opportunities, expenses occur initially and cash is received later.
In this case, Star gets cash upfront and incurs the costs of producing the book later.
It is as if Star borrowed money—receiving cash today in exchange for a future liability—and when you borrow money you prefer as low a rate as possible.
In this case the IRR is best interpreted as the rate Star is paying rather than earning, and so Star’s optimal rule is to borrow money so long as this rate is less than his cost of capital.

14. Applying The IRR Rule (cont'd)
Multiple IRRs
Suppose Star informs the publisher that it needs to sweeten the deal before he will accept it.
The publisher offers $550,000 advance and $1,000,000 in four years when the book is published.
Should he accept or reject the new offer?

15. Applying The IRR Rule (cont'd)
Multiple IRRs
The cash flows would now look like:
The NPV is calculated as:

16. Applying The IRR Rule (cont'd)
Multiple IRRs
By setting the NPV equal to zero and solving for r, we find the IRR.
In this case, there are two IRRs: 7.164% and %.
Because there is more than one IRR, the IRR rule cannot be applied.

17. Figure 7.3 NPV of Star’s Book Deal with Royalties

18. Applying The IRR Rule (cont'd)
Multiple IRRs
Between 7.164% and %, the book deal has a negative NPV.
Since your opportunity cost of capital is 10%, you should reject the deal.

19. Applying The IRR Rule (cont'd)
Nonexistent IRR
Finally, Star is able to get the publisher to increase his advance to $750,000, in addition to the $1 million when the book is published in four years.
With these cash flows, no IRR exists; there is no discount rate that makes NPV equal to zero.

20. Figure 7.4 NPV of Star’s Final Offer
No IRR exists because the NPV is positive for all values of the discount rate. Thus the IRR rule cannot be used.

21. Applying The IRR Rule (cont'd)
IRR Versus the IRR Rule
While the IRR rule has shortcomings for making investment decisions, the IRR itself remains useful.
IRR measures the average return of the investment and the sensitivity of the NPV to any estimation error in the cost of capital.

22. Textbook Example 7.1

23. Textbook Example 7.1 (cont’d)

24. Figure 7.5 NPV Profiles for Example 7.1
While the IRR Rule works for project A, it fails for each of the other projects.

25. 7.3 The Payback Rule
The payback period is amount of time it takes to recover or pay back the initial investment.
If the payback period is less than a pre- specified length of time, you accept the project.
Otherwise, you reject the project.
The payback rule is used by many companies because of its simplicity.

26. Textbook Example 7.2

27. Textbook Example 7.2 (cont'd)

28. Alternative Example 7.2 Problem
Projects A, B, and C each have an expected life of 5 years.
Given the initial cost and annual cash flow information below, what is the payback period for each project? A B C
Cost
$80
$120
$150
Cash Flow
$25
$30
$35

29. Alternative Example 7.2 Solution Payback A Project B Project C
$80 ÷ $25 = 3.2 years
Project B
$120 ÷ $30 = 4.0 years
Project C
$150 ÷ $35 = 4.29 years

30. The Payback Rule (cont’d)
Pitfalls:
Ignores the project’s cost of capital and time value of money.
Ignores cash flows after the payback period.
Relies on an ad hoc decision criterion.

31. 7.4 Choosing Between Projects
Mutually Exclusive Projects
When you must choose only one project among several possible projects, the choice is mutually exclusive.
NPV Rule
Select the project with the highest NPV.
IRR Rule
Selecting the project with the highest IRR may lead to mistakes.

32. Textbook Example 7.3

33. Textbook Example 7.3 (cont’d)

34. Alternative Example 7.3 Problem
A small commercial property is for sale near your university. Given its location, you believe a student-oriented business would be very successful there. You have researched several possibilities and come up with the following cash flow estimates (including the cost of purchasing the property). Which investment should you choose?
Project
Initial Investment
First-Year Cash Flow
Growth Rate
Cost of Capital
Used Book Store
$250,000
$55,000 4% 7%
Sandwich Shop
$350,000
$75,000 8%
Hair Salon
$400,000
$120,000 5%
Clothing Store
$500,000
$125,000
12%

35. Alternative Example 7.3 (cont’d)
Solution
Assuming each business lasts indefinitely, we can compute the present value of the cash flows from each as a constant growth perpetuity. The NPV of each project is
Thus, all of the alternatives have a positive NPV. But because we can only choose one, the clothing store is the best alternative.

36. IRR Rule and Mutually Exclusive Investments: Differences in Scale
If a project’s size is doubled, its NPV will double.
This is not the case with IRR.
Thus, the IRR rule cannot be used to compare projects of different scales.

37. IRR Rule and Mutually Exclusive Investments: Differences in Scale
Would you prefer a 500% return on $1, or a 20% return on $1 million?
While a 500% return certainly sounds impressive, at the end of the day you will only make $5.
The latter return sounds much more mundane, but you will make $200,000.
This comparison illustrates an important shortcoming of IRR: Because it is a return, you cannot tell how much value will actually be created without knowing the scale of the investment.

38. IRR Rule and Mutually Exclusive Investments: Differences in Scale (cont’d)
Consider two of the projects from Example 7.3
Bookstore
Coffee Shop
Initial Investment
$300,000
$400,000
Cash FlowYear 1
$63,000
$80,000
Annual Growth Rate 3%
Cost of Capital 8%
IRR
24%
23%
NPV
$960,000
$1,200,000

39. IRR Rule and Mutually Exclusive Investments: Timing of Cash Flows
Another problem with the IRR is that it can be affected by changing the timing of the cash flows, even when the scale is the same.
IRR is a return, but the dollar value of earning a given return depends on how long the return is earned.
Consider again the coffee shop and the music store investment in Example 7.3.
Both have the same initial scale and the same horizon.
The coffee shop has a lower IRR, but a higher NPV because of its higher growth rate.

40. IRR Rule and Mutually Exclusive Investments: Differences in Risk
An IRR that is attractive for a safe project need not be attractive for a riskier project.
Consider the investment in the electronics store from Example 7.3.
The IRR is higher than those of the other investment opportunities, yet the NPV is the lowest.
The higher cost of capital means a higher IRR is necessary to make the project attractive.

41. The Incremental IRR Rule
When choosing between two projects, an alternative to comparing their IRRs is to compute the incremental IRR, which is the IRR of the incremental cash flows that would result from replacing one project with the other.
The incremental IRR tells us the discount rate at which it becomes profitable to switch from one project to the other.
Then, rather than compare the projects directly, we can evaluate the decision to switch from one to the other using the IRR rule
Incremental IRR Investment Rule
Apply the IRR rule to the difference between the cash flows of the two mutually exclusive alternatives (the increment to the cash flows of one investment over the other).

42. Textbook Example 7.4

43. Textbook Example 7.4 (cont’d)

44. Textbook Example 7.4 (cont’d)

45. The Incremental IRR Rule (cont'd)
Shortcomings of the Incremental IRR Rule
The incremental IRR may not exist.
Multiple incremental IRRs could exist.
The fact that the IRR exceeds the cost of capital for both projects does not imply that either project has a positive NPV.
When individual projects have different costs of capital, it is not obvious which cost of capital the incremental IRR should be compared to.

46. 7.5 Project Selection with Resource Constraints
In practice, there are often limitations on the number of projects the firm can undertake.
For example, when projects are mutually exclusive, the firm can only take on one of the projects even if many of them are attractive.
Often this limitation is due to resource constraints—for example, there is only one property available in which to open either a coffee shop, or book store, and so on.

47. 7.5 Project Selection with Resource Constraints
Evaluation of Projects with Different Resource Constraints
Consider three possible projects with a $100 million budget constraint
Practitioners often use the profitability index to identify the optimal combination of projects to undertake in such situations
Table 7.1 Possible Projects for a $100 Million Budget

48. Profitability Index
The profitability index can be used to identify the optimal combination of projects to undertake.
From Table 7.1, we can see it is better to take projects II & III together and forego project I.

49. Textbook Example 7.5

50. Textbook Example 7.5 (cont’d)

51. Alternative Example 7.5 Problem
Suppose your firm has the following five positive NPV projects to choose from. However, there is not enough manufacturing space in your plant to select all of the projects.
Use the profitability index to choose among the projects, given that you only have 105,000 square feet of unused space.
Project
NPV
Square feet needed
Project 1
100,000
40,000
Project 2
88,000
30,000
Project 3
80,000
38,000
Project 4
50,000
24,000
Project 5
12,000
1,000
Total
330,000
133,000

52. Alternative Example 7.5 (cont’d)
Solution
Compute the PI for each project.
Project
NPV
Square feet needed
Profitability Index (NPV/Sq. Ft)
Project 1
100,000
40,000
2.5
Project 2
88,000
30,000
2.93
Project 3
80,000
38,000
2.10
Project 4
50,000
24,000
2.08
Project 5
12,000
1,000
12.0
Total
330,000
133,000

53. Alternative Example 7.5 (cont’d)
Solution
Rank order them by PI and see how many projects you can have before you run out of space.
Project
NPV
Square feet needed
Profitability Index (NPV/Sq. Ft)
Cumulative total space used
Project 5
12,000
1,000
2.5
Project 2
88,000
30,000
2.93
31,000
Project 1
100,000
40,000
71,000
Project 3
80,000
38,000
2.11
Project 4
50,000
24,000
2.08

54. Shortcomings of the Profitability Index
In some situations the profitability Index does not give an accurate answer.
Suppose in Example 7.5 that NetIt has an additional small project with a NPV of only $120,000 that requires 3 engineers.
The profitability index in this case is / 3 = 0.04, so this project would appear at the bottom of the ranking.
However, 3 of the 190 employees are not being used after the first four projects are selected.
As a result, it would make sense to take on this project even though it would be ranked last.

55. Chapter 8 Fundamentals of Capital Budgeting

56. 8.1 Forecasting Earnings Capital Budget Capital Budgeting
Lists the investments that a company plans to undertake
Capital Budgeting
Process used to analyze alternate investments and decide which ones to accept
Incremental Earnings
The amount by which the firm’s earnings are expected to change as a result of the investment decision

57. Revenue and Cost Estimates
HomeNet’s target market is upscale residential “smart” homes and home offices.
Based on extensive marketing surveys, the sales forecast for HomeNet is 100,000 units per year.
Given the pace of technological change, Linksys expects the product will have a four-year life.
It will be sold through high-end electronics stores for a retail price of $375, with an expected wholesale price of $260.
Linksys has completed a $300,000 feasibility study to assess the attractiveness of a new product, HomeNet.
Revenue Estimates
Sales = 100,000 units/year, Per Unit Price = $260

58. Revenue and Cost Estimates (cont'd)
Developing the new hardware will be relatively inexpensive, as existing technologies can be simply repackaged in a newly designed, home-friendly box.
Linksys expects total engineering and design costs to amount to $5 million.
Once the design is finalized, actual production will be outsourced at a cost (including packaging) of $110 per unit.
Cost Estimates
Up-Front R&D = $15,000,000
Up-Front New Equipment = $7,500,000
Expected life of the new equipment is 5 years
Housed in existing lab
Annual Overhead = $2,800,000
Per Unit Cost = $110

59. Incremental Earnings Forecast
Table 8.1 Spreadsheet HomeNet’s Incremental Earnings Forecast

60. Capital Expenditures and Depreciation
The $7.5 million in new equipment is a cash expense, but it is not directly listed as an expense when calculating earnings.
Instead, the firm deducts a fraction of the cost of these items each year as depreciation.
Straight Line Depreciation
The asset’s cost is divided equally over its life.
Annual Depreciation = $7.5 million ÷ 5 years = $1.5 million/year

61. Interest Expense
In capital budgeting decisions, interest expense is typically not included.
The rationale is that the project should be judged on its own, not on how it will be financed.

62. Taxes Marginal Corporate Tax Rate
The tax rate on the marginal or incremental dollar of pre-tax income.
Note: A negative tax is equal to a tax credit.

63. Taxes (cont'd)
Unlevered Net Income Calculation

64. Indirect Effects on Incremental Earnings
Opportunity Cost
The value a resource could have provided in its best alternative use
In the HomeNet project example, space will be required for the investment.
Even though the equipment will be housed in an existing lab, the opportunity cost of not using the space in an alternative way (e.g., renting it out) must be considered.

65. Textbook Example 8.2

66. Textbook Example 8.2 (cont'd)

67. Indirect Effects on Incremental Earnings (cont'd)
Project Externalities
Indirect effects of the project that may affect the profits of other business activities of the firm.
Cannibalization is when sales of a new product displaces sales of an existing product.

68. Indirect Effects on Incremental Earnings (cont'd)
Project Externalities
In the HomeNet project example, 25% of sales come from customers who would have purchased an existing Linksys wireless router if HomeNet were not available.
Because this reduction in sales of the existing wireless router is a consequence of the decision to develop HomeNet, we must include it when calculating HomeNet’s incremental earnings.
For the cannibalization, suppose that the existing router wholesales for $100
($25% * 100,000 units * $100/unit = $2.5 million)

69. Indirect Effects on Incremental Earnings (cont'd)
Table 8.2 Spreadsheet HomeNet’s Incremental Earnings Forecast Including Cannibalization and Lost Rent

70. Sunk Costs and Incremental Earnings
Sunk costs are costs that have been or will be paid regardless of the decision whether or not the investment is undertaken.
Sunk costs should not be included in the incremental earnings analysis.

71. Sunk Costs and Incremental Earnings (cont'd)
Fixed Overhead Expenses
Typically overhead costs are fixed and not incremental to the project and should not be included in the calculation of incremental earnings.

72. Sunk Costs and Incremental Earnings (cont'd)
Past R&D Expenditures
Money that has already been spent on R&D is a sunk cost and therefore irrelevant.
The decision to continue or abandon a project should be based only on the incremental costs and benefits of the product going forward.

73. Sunk Costs and Incremental Earnings (cont'd)
Unavoidable Competitive Effects
When developing a new product, firms may be concerned about the cannibalization of existing products.
However, if sales are likely to decline in any case as a result of new products introduced by competitors, then these lost sales should be considered a sunk cost.

74. Real-World Complexities
Typically,
sales will change from year to year.
the average selling price will vary over time.
the average cost per unit will change over time.

75. Textbook Example 8.3

76. Textbook Example 8.3 (cont'd)

77. 8.2 Determining Free Cash Flow and NPV
The incremental effect of a project on a firm’s available cash is its free cash flow.

78. Calculating the Free Cash Flow from Earnings
Capital Expenditures and Depreciation
Capital Expenditures are the actual cash outflows when an asset is purchased.
These cash outflows are included in calculating free cash flow.
Depreciation is a non-cash expense.
The free cash flow estimate is adjusted for this non-cash expense.

79. Net Working Capital
Most projects will require the firm to invest in net working capital.
Firms may need to maintain a minimum cash balance to meet unexpected expenditures, and inventories of raw materials and finished product to accommodate production uncertainties and demand fluctuations.
Also, customers may not pay for the goods they purchase immediately.
While sales are immediately counted as part of earnings, the firm does not receive any cash until the customers actually pay.
In the interim, the firm includes the amount that customers owe in its receivables.

80. Net Working Capital
Thus, the firm’s receivables measure the total credit that the firm has extended to its customers.
In the same way, payables measure the credit the firm has received from its suppliers.
The difference between receivables and payables is the net amount of the firm’s capital that is consumed as a result of these credit transactions, known as trade credit.

81. Net Working Capital
Suppose that HomeNet will have no incremental cash or inventory requirements (products will be shipped directly from the contract manufacturer to customers).
However, receivables related to HomeNet are expected to account for 15% of annual sales, and payables are expected to be 15% of the annual cost of goods sold (COGS).
HomeNet’s net working capital requirements are shown in the spreadsheet in Table 8.4.
Table 8.4 shows that the HomeNet project will require no net working capital in year 0, $2.1 million in net working capital in years 1–4, and no net working capital in year 5.
How does this requirement affect the project’s free cash flow?
Any increases in net working capital represent an investment that reduces the cash available to the firm and so reduces free cash flow.

82. Calculating the Free Cash Flow from Earnings (cont'd)
Table 8.4 Spreadsheet HomeNet’s Net Working Capital Requirements

83. Calculating the Free Cash Flow from Earnings (cont'd)
Net Working Capital (NWC)
Most projects will require an investment in net working capital.
Trade credit is the difference between receivables and payables.
The increase in net working capital is defined as:

84. Calculating the Free Cash Flow from Earnings (cont'd)
Capital Expenditures and Depreciation
Table 8.3 Spreadsheet Calculation of HomeNet’s Free Cash Flow (Including Cannibalization and Lost Rent)

85. Textbook Example 8.4

86. Textbook Example 8.4 (cont'd)

87. Calculating Free Cash Flow Directly
The term tc × Depreciation is called the depreciation tax shield.

88. Calculating the NPV HomeNet NPV (WACC = 12%)
Table 8.5 Spreadsheet Computing HomeNet’s NPV

89. Calculating the NPV
Launching the HomeNet project produces a positive NPV, while not launching the project produces a 0 NPV.

90. 8.3 Choosing Among Alternatives (cont'd)
Evaluating Manufacturing Alternatives
In the HomeNet example, assume the company could produce each unit in-house for $95 if it spends $5 million upfront to change the assembly facility (versus $110 per unit if outsourced).
The in-house manufacturing method would also require an additional investment in inventory equal to one month’s worth of production.

91. 8.3 Choosing Among Alternatives (cont'd)
Evaluating Manufacturing Alternatives
Outsource
Cost per unit = $110
Investment in A/P = 15% of COGS
COGS = 100,000 units × $110 = $11 million
Investment in A/P = 15% × $11 million = $1.65 million
ΔNWC = –$1.65 million in Year 1 and will increase by $1.65 million in Year 5
NWC falls since this A/P is financed by suppliers

92. 8.3 Choosing Among Alternatives (cont'd)
Evaluating Manufacturing Alternatives
In-House
Cost per unit = $95
Up-front cost of $5,000,000
Investment in A/P = 15% of COGS
COGS = 100,000 units × $95 = $9.5 million
Investment in A/P = 15% × $9.5 million = $1.425 million
Investment in Inventory = $9.5 million / 12 = $0.792 million
ΔNWC in Year 1 = $0.792 million – $1.425 million = –$0.633 million
NWC will fall by $0.633 million in Year 1 and increase by $0.633 million in Year 5

93. 8.3 Choosing Among Alternatives (cont'd)
Evaluating Manufacturing Alternatives
Table 8.6 Spreadsheet NPV Cost of Outsourced Versus In-House Assembly of HomeNet

94. 8.3 Choosing Among Alternatives (cont'd)
Comparing Free Cash Flows Cisco’s Alternatives
Outsourcing is the less expensive alternative.

95. 8.4 Further Adjustments to Free Cash Flow
Other Non-cash Items
(In general, other non-cash items (e.g. amortization) that appear as part of incremental earnings should not be included in the project’s free cash flow. The firm should include only actual cash revenues or expenses)
Timing of Cash Flows
(For simplicity, we have treated the cash flows for HomeNet as if they occur at the end of each year. In reality, cash flows will be spread throughout the year. We can forecast free cash flow on a quarterly, monthly, or even continuous basis when greater accuracy is required.)
Accelerated Depreciation
(With MACRS (Modified Accelerated Cost Recovery System) depreciation, the firm first categorizes assets according to their recovery period. Based on the recovery period, MACRS depreciation tables assign a fraction of the purchase price that the firm can recover each year)

96. Further Adjustments to Free Cash Flow (cont'd)
We consider a number of complications that can arise when estimating a project’s free cash flow, such as non-cash charges, alternative depreciation methods, liquidation or continuation values, and tax loss carryforwards.
Liquidation or Salvage Value (Assets that are no longer needed often have a resale value, or some salvage value if the parts are sold for scrap)

97. Textbook Example 8.6

98. Textbook Example 8.6 (cont'd)

99. Further Adjustments to Free Cash Flow (cont'd)
Sometimes the firm explicitly forecasts free cash flow over a shorter horizon than the full horizon of the project or investment. This is necessarily true for investments with an indefinite life, such as an expansion of the firm.
In this case, we estimate the value of the remaining free cash flow beyond the forecast horizon by including an additional, one-time cash flow at the end of the forecast horizon called the terminal or continuation value of the project.
Terminal or Continuation Value
This amount represents the market value of the free cash flow from the project at all future dates.

100. Textbook Example 8.7

101. Textbook Example 8.7 (cont'd)

102. Further Adjustments to Free Cash Flow (cont'd)
Tax Carryforwards
Tax loss carryforwards and carrybacks allow corporations to take losses during its current year and offset them against gains in nearby years.

103. Textbook Example 8.8

104. Textbook Example 8.8 (cont'd)

105. 8.5 Analyzing the Project Break-Even Analysis
The break-even level of an input is the level that causes the NPV of the investment to equal zero.
HomeNet IRR Calculation
Table 8.7 Spreadsheet HomeNet IRR Calculation

106. 8.5 Analyzing the Project (cont'd)
In a break-even analysis, for each parameter, we calculate the value at which the NPV of the project is zero.
Break-Even Levels for HomeNet
EBIT Break-Even of Sales
Level of sales where EBIT equals zero
Table 8.8 Break-Even Levels for HomeNet

107. Sensitivity Analysis
Sensitivity Analysis shows how the NPV varies with a change in one of the assumptions, holding the other assumptions constant.

108. Sensitivity Analysis (cont'd)
Table 8.9 Best- and Worst-Case Parameter Assumptions
for HomeNet

109. Figure 8.1 HomeNet’s NPV Under Best- and Worst-Case Parameter Assumptions

110. Textbook Example 8.9

111. Textbook Example 8.9 (cont'd)

112. Scenario Analysis
Scenario Analysis considers the effect on the NPV of simultaneously changing multiple assumptions.
Table Scenario Analysis of Alternative Pricing Strategies

113. Figure 8.2 Price and Volume Combinations for HomeNet with Equivalent NPV

114. Table 8A.1 MACRS Depreciation Table Showing the Percentage of the Asset’s Cost That May Be Depreciated Each Year Based on Its Recovery Period