Investment Appraisal Under Uncertainty: Sensitivity Analysis (example 1) – ACCA Financial Management (FM)
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Hi, Why are we referring to “contribution” in sales volume and not change in units. As for Units, it should 12.9% change. because 2.21 % of 15000 is 331.5 units and 331.5 * 2.75 (contribution) 911.6 in contribution, not the figure we require for NPV to fall to 0. Or I think it should be distinguished clearly that 2.21 % is of the contribution fall, not Volume of units. As that is different %.
Hi John, I am confused as to why the cost of capital where we applied IRR has 5329/5329+26306*5% where is 5% from?
5% is the change in interest i.e. 15% and 20%
Have you not watched the earlier lectures on the calculation of the IRR?
I have one general query, why do we not consider the cost of capital when calculating the NPV.
Please explain in detail for my understanding, i would be extremely grateful.
We do consider it! The NPV of +5329 was calculated by discounting the flows at the cost of capital in the normal way as I show in the lecture.
If you are not clear about discounting then do watch the Paper MA lectures on it, because basic discounting such as in this example is revision of Paper MA.
Got it Thanks.
You are welcome 馃檪
Hi John, thanks for these lectures
Why is the scrap value changed, surely it is 15k in 15 years?
The 15,000 is obviously only an estimate (as are all of the flows in investment appraisal questions).
Suppose we have a scenario where the values for the sales contribution for each year were diiferrent, how do we calculate the sensitivity of the project to sales contribution?
Assume in year 2 the contribution per unit was $3 and in year 4 $3.50.
We can’t in that situation. We could only calculate the sensitivity of the two contributions separately.
How about the units produced John???
Working it out on my own i had multiplied the 15000 units per annum by 15 years to get 225000 units of the life of the investment.
My workings were like this to the first example
Profit ($2.75-$1.00) $1.75/unit
**Multiplied by Units (15000pa *15) 225000 units
Total profit over the investment life $393,750,00
Multiplied by Annuity Factor 5.847370099
Present Value of all the Profits $2,302,402,00
Scrap Value * (1/1.15^15) $1,843,00
Present Value of all Inflows $2,304,245,00
Investment Initial Cost ($150,000,00)
Net Present Value $2,154,245,00
We apply the annuity factor to the equal annual cash flow (just as I do in the lecture).
I think it would help you to revise annuity factors by watching the free Paper MA lectures on investment appraisal.
hi sir i just dont get it why is there negatives and positives in the calculation of sensitivity analysis and as in the cost of investment was positive and for the sales volume is a negative sensitivity.As well how do you arrive to the cost of capital sensitivity analysis?how do you perform the calculations?
The + or – indicates whether the flows needs to increase or decrease for the NPV to be zero.
For the cost of capital we calculate the IRR as explained in an earlier chapter.
in the answer, haven’t you considered only one year worth of contribution and fixed costs? when it should be multiplied by 15 for all the years?
No multipying by the 15 year annuity factor discounts all of the 15 years.
If the sensitivity has a low percentage do we say that the component of NPV calculated is has a high sensitivity? I thought we would say the sensitivity to change is high if the percentage is low. The semantics confuse me.
The lower the % then the more sensitive it is to change.
thank you
You are welcome 馃檪
Hi, John. I don鈥檛 understand under what circumstances should fixed costs be involved in the calculation? And under what circumstances fixed costs should be ignored in the calculation . Thanks.
When calculating the NPV all incremental costs are included.
As far as calculating the sensitive of individual items, it depends what changes as a result. So if asked for the sensitivity of fixed costs then we calculate the PV of the fixed costs. However if asked for the sensitive of, for example the selling price or the contribution, the fixed costs are not relevant because they will not change if the selling price or the contribution changes.
Hey John, I’m looking for the lecture in which the IRR of a perpetuity is calculated. I remembering you explaining it but cannot find that very lecture. Could you please help me out?
I cannot remember which lecture, but the IRR of a perpetuity is simply the annual cash flow divided by the initial investment expressed as a %.
Thanks John 馃檪
You are welcome 馃檪
How have you calculated the contribution at 2.95 per unit x 15,000?
sorry was on the wrong example
issmmmm: I would really need to see the actual question to be able to answer you properly, and the ACCA has not published this question.
If it was really as you state (in which case I assume is was one of the 2 mark questions) then you would have to do it in the same way as calculating an IRR i.e. try two different tax rates and then approximate between them.
thank you very much sir for your response I will try as per your instruction .
Sir In Exam Sept 2018 there was a question related to sensitive Analysis in which examiner asked which Tax rate will be used which make NPV zero. Can you please explain how to calculate sensitive analysis for a ta rate. looking forward to your help
Thanks in Advance