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Implementing the NPV Rule
Ocean Carriers
In a recession, the selling price and the units sold may both
be lower than expected.
Breakeven Analysis
Sensitivity Analysis
Scenario Analysis
Rearranging:
Example:
rReal
1 rNom
1
1 rInf
-1000
600
650
-1000
571.43 =
600/1.05
589.57 =
650/1.052
0.04
0.092
0
300000
15.00
15.60
16.22
16.87
17.55
18.25
156000 162240 168730 175479 182498
4.00
4.16
4.33
4.50
4.68
4.87
41600
43264
44995
46794
48666
60000
60000
60000
60000
60000
18496
20052
21670
23353
25103
-300000
95904
98924 102065 105332 108729
-300000
87824
82958
78381
74074
70022
$93,259
0.04
0.05
0
300000
15.00
15.00
15.00
15.00
15.00
15.00
150000 150000 150000 150000 150000
4.00
4.00
4.00
4.00
4.00
4.00
40000
40000
40000
40000
40000
57692
55473
53340
51288
49316
17785
18539
19264
19962
20633
-300000
92215
91461
90736
90038
89367
-300000
87824
82958
78381
74074
70022
$93,259
0.04
0.05
0
300000
15.00
15.00
15.00
15.00
15.00
15.00
150000 150000 150000 150000 150000
4.00
4.00
4.00
4.00
4.00
4.00
40000
40000
40000
40000
40000
60000
60000
60000
60000
60000
17000
17000
17000
17000
17000
-300000
93000
93000
93000
93000
93000
-300000
88571
84354
80337
76511
72868
$102,641
NPV=10,000/.08-110,000=125,000-110,000 = $15,000
or
NPV=10,000/.12-110,000=83,333-110,000 = -$26,666
Dont give up the rights to the project yet! You can wait
until next year, and then commence the project if it
proves profitable at the time. There is a 50% chance the
project will be worth $15,000 next year! As a
consequence, ownership of the project has a positive value
today due to the deferral option (option to delay).
NPV = -80,000 +
[.5(Max(100,000 or 70,000))
+ .5(Max(50,000 or 70,000))].
= -80,000 + [.5(100,000) + .5(70,000)]
= -80,000 + [85,000] = $5,000
The option to abandon is worth $10,000
($20,000 if exercised, with a .5 probability of
exercise), which swings the NPV from -$5000 to
$5000.
Real options such as the options to defer,
abandon, or expand can make up a considerable
portion of a projects value.