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9-1
9-2
CHAPTER OUTLINE
Circles represent
receipt of information,
e.g., a test score.
B
C
Do not
study
STEWART PHARMACEUTICALS
Stewart Pharmaceuticals Corporation is considering
investing in the development of a drug that cures the
common cold.
A corporate planning group, including representatives
from production, marketing, and engineering, has
recommended that the firm go ahead with the test and
development phase.
This preliminary phase will last one year and cost $1
billion. Furthermore, the group believes that there is a
60% chance that tests will prove successful.
If the initial tests are successful, Stewart
Pharmaceuticals can go ahead with full-scale
production. This investment phase will cost $1.6
billion. Production will occur over the following 4 years.
9-6
,5
$
1
5
8
N
P
V
$314,60.7
(.0)
Year 1
-$1,600
Years 2-5
$7,000
(3,000)
(1,800)
(400)
$1,800
(612)
$1,188
$1,588
4
1t
1t
9-7
.
$
4
7
5
9
0
N
P
V
$19,6.04
(1)
Year 1
-$1,600
Years 2-5
$4,050
(1,735)
(1,800)
(400)
$115
(39.10)
$75.90
$475.90
4
1t
1t
9-8
N
P
V
$0
NPV = $3.4 b
Do not
invest
NPV = $0
Failure
Do not
test
Invest
NPV = $91.46 m
9-9
E
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P
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b
P
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N
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$
$c2.4,e10.6
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DECISION TO TEST
9-10
,V1038$.
$
6
$4,7,0
%
eN
R
vP
.34.18
1
4
2
9
%
75
7
1
5492.71%
9-12
BREAK-EVEN ANALYSIS
Common tool for analyzing the relationship
between sales volume and profitability
There are three common break-even
measures
Accounting break-even: sales volume at which net
income = 0
Cash break-even: sales volume at which operating cash
flow = 0
Financial break-even: sales volume at which net present
value = 0
9-15
I/Y
10
PV
1,600
PMT
FV
504.75
9-16
+ VC
+D
+FC
$5,358.71
$3,000
$1,800
$400
$158.71
$53.96
$104.75
$504.75
9-17
$5,358.71
700
= $7.66 / dose
9-18
9-19
9-21
9-22
REAL OPTIONS
The Option to Expand
Has value if demand turns out to be higher than
expected
9-23
9-25
$287.50
= $38.64
1.10
9-26
$30N
P
V
$0
Drill
Failure
Do not
drill
The firm has two decisions to make: drill or not, abandon or stay.
9-27
$412.50
= $75.00
1.10
9-28
9-29
$6,529($17.,90)2
9-30
QUICK QUIZ
What information does a decision tree provide?
What are sensitivity analysis, scenario analysis,
break-even analysis, and simulation?
Why are these analyses important, and how
should they be used?
How do real options affect the value of capital
projects?
9-31