Term
| Goal and Three techniques of what-if analysis |
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Definition
Goal is to assess the degree of forecasting risk and to identify the most critical components of the success and failure of an investment.
- Sensitivity Analysis
- Scenario Analysis
- Simulation Analysis (Monte Carlo)
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Term
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Definition
| Investigation of what happens to NPV when only one variable is changed at a time |
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Term
| Pros of Sensitivity Analysis |
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Definition
Quick and easy to do
Helps identifty "dangerous variables" (steep slope)
Provides breakeven information |
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Term
| Cons of Sensitivity Analysis |
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Definition
Only change 1 variable at a time
Says nothing about the likelihood of changes
Ignores relationship among variables |
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Term
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Definition
What happens to NPV under different cash flow scenarios, when we ask what if questions
Provides discrete probability distribution of NPV |
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Term
| Pros of Scenario Analysis |
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Definition
Change more than 1 variable at a time
Identifty what are the extremes
Identify likelihood of scenarios
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Term
| Cons of Scenario Analysis |
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Definition
Considers only of a few possible outcomes
Assumes inputs are perfectly, positively correlated |
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Term
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Definition
Very statistical program
A combination of scenario and sensitivity analysis |
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Term
| Pros of Simulation Analysis |
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Definition
Considers many possible outcomes
You determine the correlation of inputs
Able to incorporate the likelihood of changes input
Gives you a probability distribution of NPV
Ties together sensitivities and probability distributions |
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Term
| Cons of Simulation Analysis |
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Definition
Need to understand statistics
Very complex tool
Garbage in - garbage out
Doesn't say 'yes' or 'no' (no clear cut decision) |
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Term
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Definition
| Common tool for analyzing relationship between sales volume and profitability |
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Term
| Three common break-even measures |
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Definition
Accounting break-even
Cash break-even
Financial break-even
Cash BE < Accounting BE < Financial BE |
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Term
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Definition
Sales volume at which net income = 0
NI = 0
Q = (FC+D) / (P-v) |
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Term
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Definition
Sales volume at which operating cash flow = 0
OCF = 0
Q = (FC + OCF) / (P - v) (ignore taxes) |
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Term
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Definition
Sales volume at which net present value = 0
(NPV = 0) |
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Term
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Definition
Occurs when company has limited resources
- Soft rationing - limited resources are temporary, often self-imposed
- Hard rationing - capital will never be available for the project |
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Term
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Definition
| Is the right (not the obligation) to buy & sell an asset for a specified price over a specified period of time |
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Definition
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Definition
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Term
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Definition
| The right to buy & sell on the expiration date |
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Term
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Definition
| The right to buy & sell up to and on the expiration date |
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Term
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Definition
| The specified price in the option contract at which you can buy or sell |
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Term
| Option value/premium/price |
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Definition
| The price you pay for the option (right to buy & sell) |
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Term
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Definition
| Value of the call at expiration |
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Term
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Definition
If at expiration, stock price is less than exercise price -- let it expire
If at expiration, stock price is higher than exercise price -- exercise and profit the difference |
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Term
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Definition
If at expiration, stock price is less than exercise price -- let exercise and profit the difference
If at expiration, stock price is higher than exercise price -- let it expire |
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Term
| Five factors/determinants of Option Value |
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Definition
Stock price
Exercise price
Time to expiration
Risk-free rate
Variance (Volatility of the market) |
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Term
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Definition
Stock Price (+)
Exercise Price (-)
Time to expiration (+)
Risk-free rate (+) - discount rate on exercise price (interest rate goes up, PV of exercise goes down)
Variance (+) - more volatile the market - more valuable the options will be |
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Term
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Definition
Stock Price (-)
Exercise Price (+)
Time to expiration (+)
Risk-free rate (-) - discount rate on exercise price (interest rate goes up, PV of exercise goes down)
Variance (+) - more volatile the market - more valuable the options will be |
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Term
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Definition
Value is based on an underlying asset that is traded
Payoff is specified in a contract |
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Term
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Definition
Value is based on an underlying asset that is not traded
Found or created inside projects - payoffs can be varied |
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Term
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Definition
Timing - Delay
Growth - expansion of product line, new products/services, new geographic markets
Abandonment - contraction, temporary suspension
Flexibility |
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Term
| Methods for valuing real options |
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Definition
Qualitative assessment of real option value (use five factors)
Financial option valuation models
Decision tree analysis |
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Term
| Financial option valuation models |
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Definition
Black-Scholes option pricing model (only works well with 1 year horizon)
Binomial option pricing model (multi time period) |
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Term
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Definition
a decision support tool that uses a tree-like graph or model of decisions and their possible consequences
Nodes - discussion point
Branch - each possible outcome
Probabilities - equal to 1 at each node |
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