Discounted Cash Flow Modelling and Sensitivity and Risk Analysis
Description
Blue Corn Manufacturing Ltd is in the business of automobile and other ancillary services. The company wants to start its subsidiary business in China as an expansion plan for assembling the auto part. The company’s Chief Operating Officer (COO) after taking into consideration the firm’s portfolio of investments has derived a Weighted Average Cost of Capital (WACC) of 12% as the appropriate discount rate for calculating the firm’s Net Present Value (NPV).
Given the uncertainties surrounding Brexit and the current COVID-19 pandemic, the firm’s COO has asked you, the risk analyst to model the following uncertain inputs, using appropriate probability distribution functions.
Following a detailed analysis of the firm’s historical data, you have decided to use the following distributions and parameters to model the uncertain inputs:
Table 1: Uncertain Inputs and Parameters of Distributions
Uncertain Inputs Distribution Parameter 1 Parameter 2 Parameter 3
Investment Cost Triangular £90,000 £100,000 £150,000
Year 1 Revenue Triangular £80,000 £100,000 £110,000
Annual Fixed Cost Triangular £32,000 £35,000 £38,000
Annual Revenue Growth Rate Normal 5% 8%
Annual Variable Cost
Percentage
Normal 50% 2%
Use the following Sampling Settings:
Sampling Type: Latin Hypercube.
Random Number Generator: Mersenne Twister.
Initial Seed: Fixed at 12345.
For the purpose of this coursework, you are required to do the following:
1. Calculate the Discounted Cash Flows (DCF) for 10-years and derive the Net Present Value using the uncertain input variables. (5 Marks)
2. Perform a single simulation of 10,000 iterations for the NPV model and determine the probability of getting a negative (zero) NPV at 95% Confidence Interval (2 Marks)
3. Perform sensitivity analysis for the NPV output to determine the variable with the largest impact on NPV (Biggest Driver of NPV) using the following:
a) Change in Output. (2 Marks)
b) Regression Coefficient. (2 Marks)
c) Correlation Coefficient. (2 Marks)
d) Contribution to Variance. (2 Marks)
Total (15 Marks)
Write a Report to your COO to communicate the findings from your analyses. Describe the purpose and result of your analyses.
