Capital Budgeting Case
FINC 5000 2014
BUT FIRST: YOUR SCORES (MID EXAM)
100
Average 52
90
80
70
60
scores class A
50
average score class A
40
30
20
10
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23
SCORES CLASS B (MID EXAM)
Average 45
90
80
70
60
50
Class B scores Mid Exam
40
Class B average
30
20
10
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 27
KEY ASSUMPTIONS
Cost of constructing Magic Kingdom $ 3 billion; $ 2 billion to be spent right
now and $ 1 billion to be spent one year from now
Disney has already spent $ 0.5 billion on this project, researching the
proposal and getting the necessary Brazilian licenses for the park; none
of this money can be recovered if the park is not built (sunk cost)
The cost of constructing Epcot II will be $ 1.5 billion with $ 1 billion to be
spent at the end of the second year and $ 0.5 billion at the end of the
third year
Key Revenue Assumptions- (Marketing base case)
REVENUES IN M USD
YEAR
Magic Kingdom
1
$0
2
$1,000
3
$1,400
4
$1,700
5
$2,000
6
$2,200
7
$2,420
8
$2,662
9
$2,928
10
$2,987
Epcot II
$0
$0
$0
$300
$500
$550
$605
$666
$732
$747
Resort Properties
TOTAL
$0
$250
$350
$500
$625
$688
$756
$832
$915
$933
$0
$1,250
$1,750
$2,500
$3,125
$3,438
$3,781
$4,160
$4,575
$4,667
Key Expenses
Based on Sement Analysis of Walt Disney’s 10K and 10Q reports the operating
expenses are assumed to be 60% of Revenues at the parks and 75% of
Revenues at the Resort Properties
Disney HQ will allocate Corporate G&A costs to this project based on Revenues: G&A
will be 15% of Revenues each year
Cost analysis has pointed out that one third of these expenses are variable (a
function of Revenues) and two thirds are fixed cost
Depreciation and Capital Maintenance
Year
1
2
3
4
5
6
7
8
9
10
Depreciation
Capital Maintenance
% of Book Value
% of Depreciation
0.00%
0.00%
12.50%
50.00%
11.00%
60.00%
9.50%
70.00%
8.00%
80.00%
8.00%
90.00%
8.00%
100.00%
8.00%
105.00%
8.00%
110.00%
8.00%
110.00%
Note that Capital Maintenance are low in
early years but increases as the Park ages…
Other assumptions…
Disney will have to maintain non-cash working capital (primarily inventory netted
against accounts payable) of 5% of Revenues with the investments being made at
the end of each year…
The income from the investment will be taxed at Disney’s marginal tax rate of 38%
(35% corporate income tax US + 3% state tax)
Starting to get the Picture:
Book Capital, Working Capital and Depreciation…
Year $ Mln.
Book Value Pre Project
Depreciation Pre Project
Magic Kingdom Rio
Epcot II Rio
Capital Maintenance
Depreciation Fixed Assets
Book Value New Fixed Assets
Book Value Working Capital
Total Capital invested in Project
0
$500
$50
1
$450
$50
2
$400
$50
3
$350
$50
4
$300
$50
5
$250
$50
6
$200
$50
7
$150
$50
8
$100
$50
9
$50
$50
10
$0
$50
$2,000
$0
$0
$0
$2,000
$1,000
$0
$0
$0
$3,000
$0
$1,000
$188
$375
$3,813
$0
$500
$252
$419
$4,146
$0
$0
$276
$394
$4,028
$0
$0
$258
$322
$3,964
$0
$0
$285
$317
$3,932
$0
$0
$314
$314
$3,932
$0
$0
$330
$314
$3,948
$0
$0
$347
$316
$3,979
$0
$0
$350
$318
$4,011
$0
$0
$63
$88
$125
$156
$172
$189
$208
$229
$233
$2,500
$3,450
$4,276
$4,584
$4,453
$4,370
$4,304
$4,271
$4,256
$4,258
$4,244
12.5% of book value at the end of prior year ( $3000)
Estimate Accounting Earnings on Rio Disney:
Year
Magic Kingdom Revenues
Epcot Rio Revenues
Resorts&Properties Revenues
TOTAL REVENUES
1
$0
$0
$0
$0
2
$1,000
$0
$250
$1,250
3
4
$1,400 $1,700
$0
$300
$350
$500
$1,750 $2,500
5
$2,000
$500
$625
$3,125
6
$2,200
$550
$688
$3,438
7
$2,420
$605
$756
$3,781
8
$2,662
$666
$832
$4,160
9
10
$2,928 $2,987
$732
$747
$915
$933
$4,575 $4,667
Magic Kingdom Direct Expenses
Epcot Rio Direct Expenses
$0
$0
$600
$0
$840 $1,020
$0
$180
$1,200
$300
$1,320
$330
$1,452
$363
$1,597
$399
$1,757 $1,792
$439
$448
Resort&Properties Direct Expenses
$0
$188
$263
$375
$469
$516
$567
$624
TOTAL DIRECT EXPENSES
$0
$788
$1,103 $1,575
$1,969
$2,166
$2,382
$2,620
$50
$0
$425
$188
$469
$263
$444
$375
$372
$469
$367
$516
$364
$567
$364
$624
$366
$686
$368
$700
OPERATING INCOME
Taxes 38%
-$50
-$19
-$151
-$57
-$85
-$32
$106
$40
$315
$120
$389
$148
$468
$178
$552
$210
$641
$244
$659
$250
Operating Income after Tax
-$31
-$94
-$53
$66
$195
$241
$290
$342
$397
$409
Depreciation
Allocated G&A costs
0
$686
$700
$2,882 $2,940
The Accounting View of Return:
YEAR After Tax
Operating
Income
Pre-Project
Fixed
Working
TOTAL
Average
ROC
Investment
Assets
Capital
CAPITAL
Book Value
average
M USD
0
1
2
3
4
5
6
7
8
9
10
AVERAGE
$0
-$31
-$93
-$52
$66
$196
$241
$290
$341
$397
$408
ROC
of Capital
$500
$450
$400
$350
$300
$250
$200
$150
$100
$50
$0
$2,000
$3,000
$3,813
$4,145
$4,027
$3,962
$3,931
$3,931
$3,946
$3,978
$4,010
$0
$0
$63
$88
$125
$156
$172
$189
$208
$229
$233
$2,500
$3,450
$4,276
$4,583
$4,452
$4,368
$4,303
$4,270
$4,254
$4,257
$4,243
ROC calculated over average capital in that year
ROC calculated over Start Capital in that year
NA
$2,975
$3,863
$4,430
$4,518
$4,410
$4,336
$4,287
$4,262
$4,256
$4,250
NA
-1.04%
-2.41%
-1.17%
1.46%
4.44%
5.56%
6.77%
8.00%
9.33%
9.60%
4.05%
-1.24%
-2.70%
-1.22%
1.44%
4.40%
5.52%
6.74%
7.99%
9.33%
9.58%
3.99%
How to judge this return? Compare with hurdle rate….
The computed return on Capital is about 4% ; to judge if this is sufficient we will need
to compare this with a hurdle rate. But which hurdle rate is the right comparison?
A) The risk free rate 3.5% (2010)
B) The cost of equity of Disney (9%)
C) The cost of equity of Disney Theme Parks (8.2%)
D) The cost of capital of Disney as a company (7.5%)
E) The cost of capital of Disney Theme Parks (6.6%)
F) None of the above is right…..
Should there be a risk premium for foreign projects?
Exchange rate in general should be diversifiable risk (and hence should not command a premium) if:
The company has projects in a large number of countries (or)
The investors in the company are globally diversified
(For Disney this risk should not affect the cost of capital ; consequently one would not adjust the cost of capital for
Disney investments in other mature markets like Germany, the UK and France)
The same diversification argument we would use to justify no adjustment for the cost of capital because of
political risk. However some aspects of political risk especially in emerging markets will be hard to diversify
and may affect the cash flows by reducing the expected life of the project
(For Disney we will incoprporate this risk in the cost of capital when it invests in Brazil or any other emerging
market )
Estimating a hurdle rate for Disney Rio…
If the country risk premium for Brazil is 2.5% (Moody’s based on bonds)
And we scale this up to equity by taking the relative volatility of Brazilian equity
(BOVESPA) to Brazilian Government bonds (STDEV(Bovespa)/STDEV(Gov Bond)=
34%/21.5% the additional risk premium for Brazil over the US is
34/21.5*2.5%=3.95%
The cost of equity in the US is now: 3.5%+.78(beta)*(6% US spread+3.95% Brazil
country risk)= 11.3%
And the cost of capital US ($) : 65%* 11.3%+35%*3.7% (cost of debt after tax)=8.6%
Would you conclude…
Do not invest in this park (ROC 4% < cost of capital 8.6%)
Or would you have second thoughts?
We have calculated returns for 10 years but a theme park most likely will be operating longer and
still have a value after it stops to operate?
For existing investments in 2010 the data for Disney show:
Company
EBIT(1-t)
BV Debt
BV Equity
Cash
BV Capital
ROC%
Cost of
Capital %
ROC%Cost of
Capital%
Disney
$ 4395 M
$ 16892 M
$ 30753 M
$ 3670 M
$ 43975 M
9.91%
7.51%
2.4%
HOMEWORK ASSIGNMENT: APPLICATION TEST
Compute the after tax ROC% for your company in FY 2010 use:
ROC (after Tax)= EBIT(1-tax rate)/( BV of Debt + BV of Equity – Cash)previous year
For Disney this was: 9.91% (see last slide)
Now Calculate the Return Spread= After Tax ROC% - Cost of Capital% (Google for
the cost of capital of your company later in the course you will learn how to
calculate it)
For Disney this was: 2.4% (see last slide)
For the most recent period calculate EVA (Economic Value Added)= Return
Spread*(BV of Debt + BV of Equity – Cash) previous year
For Disney this was: $ 1,057 M
Now the Cash Flow of Rio Disney…
Year M USD
0
1
2
3
4
5
6
7
8
9
10
Operating Income
-$50
-$150
-$84
$106
$315
$389
$467
$551
$641
$658
Taxes
-$19
-$57
-$32
$40
$120
$148
$178
$209
$244
$250
Operating Income after Tax
-$31
-$93
-$52
$66
$195
$241
$289
$342
$397
$408
$50
$425
$469
$444
$372
$367
$364
$364
$366
$368
$2,500
$1,000
$1,188
$752
$276
$258
$285
$314
$330
$347
$350
$0
$0
$63
$25
$38
$31
$16
$17
$19
$21
$5
-$2,500
-$981
-$919 -$360
$196
$278
$307
$322
$357
$395
$421
+ Depreciation
- Capital Expenditures
- Change in Working Capital
CASH FLOW FIRM
To get from income to cash flow we:
1) Added back all non cash charges such as depreciation
2) Subtracted out the capital expenditures
3) Subtracted out the change in non cash working capital
THE DEPRECIATION TAX BENEFIT (TAX SHIELD)
While depreciation reduces taxable income and taxes, it does not reduce
the cash flows !
The benefit of depreciation is therefore the Tax benefit.
In general this Tax benefit can be written as: Tax Benefit= Depreciation* Tax rate
For Disney with a tax rate of 38% the depreciation tax savings are:
Year
M USD
1
2
3
4
5
6
7
8
9
10
depreciation
50
425
469
444
372
367
364
364
366
368
Depreciation
*tax rate
19
162
178
169
141
139
138
138
139
140
Note: The tax benefits from depreciation and other non-cash charges is greater the
higher your company’s tax rate
Note: Non cash charges that are not tax deductible (amortization of goodwill) have no
tax benefits and thus have no effect on cash flows
DEPRECIATION METHODS
You learned in Accounting:
Questions:
Straight Line depreciation (SL)
1) Which method will result in a higher
net income this year (now)
Accelerated depreciation (DDB, SYD etc.)
SL= (P-R)/n
DDB = 2*SL%
SYD= Sum of year digits
2) Which method will result in a higher
cash flow this year (now)
3) Assume; EBITDA=100 P=100 R= 20
n= 5 year tax=40% calculate SL and
DDB this year compare income and
cash flow for each method
ANSWER..
SL depreciation= (P-R)/n= (100-20)/5=16
DDB depreciation=2*SL%=1/n*2=40%
Year 1 depreciation under DDB 40
EBITDA=100
SL income= 100-16=84
DDB income= 100 -40=60
So we conclude:
SL income> DDB income
DDB cash flow> SL cash flow
SL cash flow= (100 – 16)*(1-40%tax)=50.4
50.4+16=66.4
DDB cash flow= (100 -40)*(1-40%)=36
36+40=76
THE CAPITAL EXPENDITURE EFFECTS
Capital Expenditure (CAPEX) do cause cash outlows
CAPEX can be categorized into two groups:
1)Growth CAPEX designed tp create new assets
2)Maintenance CAPEX designed to keep existing assets
The need for Maintenance CAPEX increases wit the life of the project; 25 year
projects need more maintenance CAPEX than 5 year projects
Clearly the Disney Rio Project is a long term project that requires Maintenance
CAPEX
TO CAPEX OR NOT TO CAPEX ?
Assume you run a software business
and you have an expense of $90 M from
the production and distribution of
promotion CD’s in Magazines
ANSWER:
(assume Income before this expense=100 tax=40%)
Expense it:
Income : 100 – 90
Your Accountant tells you you can
expense it or depreciate it over 3 years.
Depreciate it:
Which will have a more positive effect on
this years income?
Depreciation/Capitalizing expenses results in higher
income!
Which will have a more positive effect on
this year’s cash flow?
Expense it:
Income: 100 – 30
Cash Flow: (100-90)(1-40%)+depreciation(=0)
Depreciate it:
Cash Flow: (100-30)(1-40%)+depreciation(30)
WORKING CAPITAL (WC) EFFECTS
Money invested in inventory and Accounts Receivable can not be used
elsewhere…thus is a drain on cash flow
This drain is reduced to the degree suppliers credit is provided
Investments in WC are Cash Out flows any reduction in WC is a Cash inflow
At the end of the project life WC investments need to be salvaged
WC requirements need to be estimated and brought into the Project cash flows
INCREMENTAL CASH FLOWS OF DISNEY RIO:
Year M USD
tax rate=38%
0
1
2
3
4
5
6
7
8
9
10
Operating Income
-$50
-$150
-$84
$106
$315
$389
$467
$551
$641
$658
Taxes
-$19
-$57
-$32
$40
$120
$148
$178
$209
$244
$250
Operating Income after Tax
-$31
-$93
-$52
$66
$196
$241
$290
$341
$397
$408
$50
$425
$469
$444
$372
$367
$364
$364
$366
$368
$2,500
$1,000
$1,188
$752
$276
$258
$285
$314
$330
$347
$350
- Change in WC
$0
$0
$63
$25
$38
$31
$16
$17
$19
$21
$5
Cash Flow Firm
-$2,500
-$981
-$918
-$360
$196
$279
$307
$323
$357
$395
$422
$19
$19
$19
$19
$19
$19
$19
$19
$19
$19
$0
$78
$109
$155
$194
$213
$234
$258
$284
$289
-$1,000
-$859
-$270
$332
$454
$501
$538
$596
$660
$692
+ Depreciation
- CAPEX
+ Pre project investment
- Pre project depreciation*tax
rate
$500
+ Fixed SG&A *(1-tax rate)
Incremental Cash Flow
-$2,000
Note: $500M has been spent and the $50M in depreciation will thus exist anyway no matter
the project will be done…
The pre-project depreciation tax advantage is thus added back as a cash outflow ($19)
Note: two thirds of the SG&A is fixed; this cost will still be there if the project will not be done
and is thus not an incremental cash flow of this project (add back this amount *( 1-38%))
SUNK COSTS
Any cost/expenditure that has been
incurred and can not be recovered (even
if a project is rejected) is a Sunk Cost
Examples;
test market for a consumer product
R&D expenses for a drug
Behavioral research:
Managers find it impossible to ignore
Sunk Costs…
CASE:
A Consumer Product Company has spent
$100M on test Marketing; the project
(excluding the cost of test marketing) will
generate $25M in value for the
company…Should the company take the
investment?
Now assume that every investment that
this company shares has the same
characteristics (Sunk Cost>Added Value)
The company is clearly not able to
survive?
ALLOCATED COSTS
Firms allocate costs to individual projects from a central pool (SG&A-Corporate
Overheads) based on the Characteristics of the project based on Sales Revenues or
Earnings…
For large companies this could be a significant cost and result in Rejection of the
project
The part of the cost that are not incremental should be added back to the project if
the total allocated costs are already subtracted from income like in the Disney
example (they would exist anyway) this would make the project for the firm look
unnecessarily worse. Thus only the incremental (variable) component of allocated
costs should show up in the project analysis!
HOW TO BREAK OUT SG&A IN FIXED AND VARIABLE COSTS ?
Assume you gathered the following data
for your company:
Question: what % of SG&A cost is
variable?
YEAR
Sales $M
SG&A $M
1
1,000
250
2
1,200
270
3
1,500
300
Answer: Variable cost vary with Sales, Fixed cost do not vary with sales and thus
if Sales increase with $500M between year 1 and year 3 the SG&A increases
with $50M i.e. every extra $ in sales triggers $0.10 in additional SG&A cost
(10% of sales)
So if the sales is $1,000 approximately $ 100M of the SG&A is Variable and
thus the remainder $ 150M must be Fixed!
The Total Cost function would be: TC= $150M + $0.10*Sales Revenues
TIME WEIGHTED CASH FLOWS
Incremental cash flows in early years are
worth more than cash flows later
REMINDER: (note: i>g)
Cash flows across time can not be
added up ; they have to be brought back
to the same point in time before
aggregation
Annuity:
You have learned in week 2 (Time Value
of Money) that we need to take the
Present Values of future cash flows
Growing Annuity:
$C=cash flow in $; i=hurdle rate;g=growth rate; n=
number of years
$C(1-(1/(1+i)n)/i
$C(1+g)(1-((1+g)n/(1+i)n))/(i-g)
Perpetuity:
$C/i
Growing Perpetuity:
$C/(i-g)
MEASURES OF RETURN
NPV (Net Present Value)
IRR (Internal Rate of Return)
Sum of present values of all cash flows
on the project including the initial
investment, with all cash flows being
discounted at the appropriate hurdle
rate (cost of capital)
The IRR is the discount rate that sets the
NPV of the Project’s cash flows to zero.
Decision Rule: If NPV>0
Accept the project
The IRR is calculated on the incremental
cash flows of the project!
Decision Rule: If IRR> Hurdle rate
Accept the project
CLOSURE ON CASH FLOWS
In a project with a finite life you need to
compute a salvage value usually equal
to the book value if fixed assets and WC
at the end of the project’s life…
In a project with an infinite life we
compute cash flows for a reasonable
period of time and then compute a
Terminal Value (TV) which is the Present
Value of all cash flows after the
estimation period ends…
This is in effect a Growing Perpetuity for
a project like Disney Rio ….
Salvage Value finite project:
Book Value Fixed Assets + Book Value WC (you
will need to make projected Balance sheets)
Salvage Value=Terminal Value (TV):
In Disney Rio case:
TV in year 10= Cash Flow year 11/(cost of
capital –growth rate)
Cash Flow year 10 is calculated as $692M
Assuming a perpetual growth of 2% and a cost
of capital of 8.6%
TV= $692M(1+2%)/(8.6% - 2%)= $ 10,669M
If Disney exits the project after 10 years the
future cash flows after that indicate a
remaining value of $ 10,669M!
THE PROJECT DISNEY RIO INCLUDING TV YIELDS A NPV OF:
Present
Year
Annual Cash Flow Terminal Value Value
0
-$2,000
-$2,000
1
-$1,000
-$921
2
-$860
-$729
3
-$270
-$211
4
$332
$239
5
$453
$300
6
$502
$305
7
$538
$302
8
$596
$307
9
$660
$313
10
$692
$10,669 $4,970
NPV
$2,877
Discounted at the Cost of Capital of Rio Disney of 8.6%
in M USD
This makes the argument that….
Project Disney Rio should be accepted:
The positive NPV of $ 2,877 M suggests
that this project will add value to the firm
and earn a return in excess of the cost
of capital
By taking this project (under the
assumptions) Disney will increase its
value by $ 2,877 M
NPV Disney Rio at selected Hurdle Rates
M USD
NPV
IRR%= 16.2%
$4,000
$3,000
$2,000
$1,000
NPV Disney Rio at selected Hurdle Rates
$0
-$1,000
Hurdle Rate
hurdle rate
NPV M USD
8%
9%
10%
11%
12%
13%
14%
15%
16%
18%
20%
$3,220 $2,675 $2,183 $1,737 $1,332
$964
$631
$328
$52
-$427
-$825
NPV Disney Rio at selected Hurdle Rates
M USD
NPV
IRR%= 16.2%
$4,000
$3,000
$2,000
$1,000
NPV Disney Rio at selected Hurdle Rates
$0
-$1,000
Hurdle Rate
hurdle rate
NPV M USD
8%
9%
10%
11%
12%
13%
14%
15%
16%
18%
20%
$3,220 $2,675 $2,183 $1,737 $1,332
$964
$631
$328
$52
-$427
-$825
THE IRR% SUGGESTS:
The project Disney Rio is a good project!
This project provide a return of 16.2% and this is significant higher than the Cost of
Capital (8.6%)
IRR% and NPV will yield similar results most of the time…
The analysis was done in USD; since this is a project in Brazil
would the conclusion be different if we had done the analysis in
Brazilian Reals?
USD VERSUS BRL AND USD VERSUS CNY (5 YEARS)
USD lost 20% over the past 5 years against the BRL and against the CNY
Imagine how this would effect your investment Projects ….?
THE CONSISTENCY RULE OF CASH FLOW
The Cash Flow on a project and the
discount rate used should ne defined in
the same terms
So if the cash flow is in BRL then the
discount rate also has to be in BRL
If the Cash Flow is nominal (uncorrected
for inflation) then the discount rate
should also be nominal
If consistency is maintained this way
then the project conclusions should be
the same no matter what currency is
used…
Nominator* (1.07/1.02)
Denominator* (1.07/1.02)
NPV in BRL=NPV in USD
Case:
Assume the inflation in Brazil is 7% and
in the US 2%
In 2010 when this analysis was done
2.04 BRL/USD (now already 1.73
BRL/USD)….
Assuming PPP the expected exchange
rate going forward should be:
Future Exchange rate in period
t=(1+inflation Brazil)/(1+inflation US)*
Exchange rate today
Thus Exchange rate in 2011 was
predicted to be: (1.07)/(1.02)*
2.04BRL= 2.14 BRL/USD we now know
that was wrong…
Similarly the cost of capital in BRL would
be : (1+cost of capital US)*((1+inflation
Brazil)/(1+inflation US))= (1.086)*
(1.07/1.02)= 13.94%
DISNEY RIO IN BRL (NPV CALCULATION)
Year
Cash Flow in M USD USDBRL=X Cash Flow in M BRL
(201)0
Present Value at 13.94%
discount rate
-$2,000
2.04
-4,080.00
-4080M BRL
1
-$1,000
2.14
-2,140.00
-1878.14
2
-$860
2.24
-1,929.49
-1486.19
3
-$270
2.35
-635.98
-429.92
4
$333
2.47
821.40
487.32
5
$453
2.59
1,175.13
611.87
6
$502
2.72
1,363.47
623.06
7
$538
2.85
1,534.43
615.39
8
$596
2.99
1,781.90
627.19
9
$660
3.14
2,070.09
639.48
10
$11,361
3.29
37,400.50
10139.72
TOTAL
NPV (BRL)= BRL 5870/2.04 (today is 2010)=
$ 2,877 M
5869.78M BRL
Uncertainty in Project analysis:
Based on both the NPV and IRR% the Disney Rio project seems to be a good project, however we
have made many assumptions; which of the following may effect your assessment of the
value?
1)
The revenues may be over-estimated by the Marketing department
2)
The actual costs of operating the park may be higher than estimated
3)
Tax rates may go up
4)
The exchange rate USD/BRL may turn unfavorably
5)
Interest rates may cause the cost of capital to rise
6)
Risk premiums and default spreads may increase
7)
Estimated Maintenance CAPEX proofs to be higher than estimated
8)
The FIFA 2014 Finals, and the Olympics 2016 will take visitors away
9)
Heavy Monsoon rains (December-March) cause flooding in Disney Rio
10) All of the above…
How would you respond to these uncertainties? Will
you wait, walk away from the project, ignore
uncertainties, or…?
One solution: how quickly can you get your money
back?
Year
Cash Flow
Cum Cash Flow
PV Cash Flow
Cum PV Cash Flow
0
-$2,000
-$2,000
-$2,000
-$2,000
1
-$1,000
-$3,000
-$921
-$2,921
2
-$860
-$3,860
-$729
-$3,650
3
-$270
-$4,130
-$211
-$3,861
4
$332
-$3,798
$239
-$3,622
5
$453
-$3,345
$300
-$3,322
6
$502
-$2,843
$305
-$3,017
7
$538
-$2,305
$302
-$2,715
8
$596
-$1,709
$307
-$2,408
9
$660
-$1,049
$313
-$2,095
10
$692
-$357
$303
-$1,792
11
$706
$349
$284
-$1,508
12
$720
$1,069
$267
-$1,241
13
$735
$1,804
$251
-$990
14
$749
$2,553
$236
-$754
15
$764
$3,317
$221
-$533
16
$780
$4,097
$208
-$325
17
$795
$4,892
$195
18
$811
$5,703
$183
10.5 YEAR
17.7 YEAR
-$130
$53
A more sophisticated approach: Sensitivity Analysis…
BASE CASE
NPV
IRR
(Cost of Capital 8.6%)
$ M
%
2,877
16.2
How to Manage this risk:
Main Risks/ Sensitivity:
Assumed
NPV
MUSD
Impact in M
USD
IRR%
Impact in IRR%
Number of visitors
-10%
1,211
-1,666
11.9
-4.3
1) Marketing Promotion
Ticket Price
-20%
231
-2,646
9.5
-6.7
2) Price packages
plus 5%
1876
-1,001
14.2
-2
Accident
+1/5YR
1988
-889
15.1
-1.1
Monsoon
+1/5YR
2314
-563
15.8
-0.4
-1672
-4,549
5.2
-11
Operational Cost
BRL/USD
-30%
3) Hedging/Derivatives
WACC
plus 3%
1456
-1,421
12.8
-3.4
4) Local project financing
Tax Rate US
plus 5%
933
-1,944
10.8
-5.4
5) Set up SPE's
Caveats in sensitivity analysis…
Analyzing the effects of changing assumptions we often hold all other factors
constant (The ceteris paribus condition); in the real world variables move together
The objective of a sensitivity analysis is that we make better decisions not to churn
out more tables and numbers
Not every thing is worth varying; sometimes less is more…
A picture is worth a thousand words and tables…and here is a good one (next slide)
The visual display of quantitative information
"It may well be the best statistical graphic ever drawn."
Charles Joseph Minard's 1861 thematic map of Napoleon's
ill-fated march on Moscow…
Week 6 Homework Assignment: iPhone∞
CONFIDENTIAL‐ For Your Eyes Only FINC 5000 week 6 Investment Analysis Case Study iPhone¥ â ‐ INVESTMENT CASE This case is a group project that will be due on 17 December 2011. I.e. your output will be printed off in hard copy (one report per team). Each report has a cover page indicating clearly: who contributed to the report and their student ID. The summary information on the Analysis contains: Your decision on the Investment: Invest or Do Not Invest Cost of Capital: % Return On Capital: % NPV‐10 year life of project: $ NPV‐longer life project: $ Keep your report brief! On timing of cash flows assume: Right now is t=0 thus next year is t=1. Note that this case was developed in 2010 and thus t=1 is 2011 and t=0 is 2010; also the estimated yields and spreads are based on the last information in 2010 (of course the world has changed since then but you have to assume we are in 2010 now!) If you have any questions let me know.
Disclaimer: This case is a product of fantasy and vision and does not relate to any existing investment project at Apple Inc. Any similarities with reality are purely coincidence. â
The new Apple iNfinite Shanghai 26 November 2011