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Chapter 26: Q29RQ (page 1464)

How can spreadsheet software, such as Excel, help with sensitivity analysis?

Short Answer

Expert verified

All investing is probabilistic because it is impossible to know with certainty what will occur in 5, 10, or 15 years, but it is possible to provide a realistic range of prospective outcomes, so that investors can change their assumptions in a model and examine the output under various alternative scenarios by using sensitivity analysis in Excel or other spreadsheet program.

Step by step solution

01

Definition

Sensitivity analysis is the examination of several causes of uncertainty in model input might be allocated to the uncertainty in the model's output, whether it is numerical or not.

02

Advantages

Sensitivity analysis provides decision-makers with various outcomes to aid in better commercial decision-making. Predictions are more accurate because they thoroughly analyze the factors that influence them.

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Most popular questions from this chapter

Using NPV to make capital investment decisions Holmes Industries is deciding whether to automate one phase of its production process. The manufacturing equipment has a six-year life and will cost \(910,000.

Year 1 \) 262,000

Year 2 254,000

Year 3 222,000

Year 4 215,000

Year 5 200,000

Year 6 175,000

Requirements

  1. Compute this project’s NPV using Holmes’s 14% hurdle rate. Should Holmes invest in the equipment?

Holmes could refurbish the equipment at the end of six years for \(104,000. The refurbished equipment could be used one more year, providing \)77,000 of net cash inflows in year 7. Additionally, the refurbished equipment would have a $55,000 residual value at the end of year 7. Should Holmes invest in the equipment and refurbish it after six years? (Hint: In addition to your answer to Requirement 1, discount the additional cash outflow and inflows back to the present value.)

Hamilton Company is considering two capital investments. Both investments have an initial cost of \(7,000,000 and total net cash inflows of \)16,000,000 over 10 years. Hamilton requires a 20% rate of return on this type of investment. Expected net cash inflows are as follows:

Year

Plan Alpha

Plan Beta

1

\(1,600,000

\)1,600,000

2

\(1,600,000

2,200,000

3

\)1,600,000

2,800,000

4

\(1,600,000

2,200,000

5

\)1,600,000

1,600,000

6

\(1,600,000

1,500,000

7

\)1,600,000

1,300,000

8

\(1,600,000

1,100,000

9

\)1,600,000

900,000

10

\(1,600,000

800,000

Total

\)16,000,000

\(16,000,000

Requirements

1. Use Excel to compute the NPV and IRR of the two plans. Which plan, if any, should the company pursue?

2. Explain the relationship between NPV and IRR. Based on this relationship and the company’s required rate of return, are your answers as expected in Requirement 1? Why or why not?

3. After further negotiating, the company can now invest with an initial cost of \)6,500,000. Recalculate the NPV and IRR. Which plan, if any, should the company pursue?

Using IRR to make capital investment decisions

Refer to the data regarding Hawkins Products in Exercise E26-25. Compute the IRR of each project, and use this information to identify the better investment.

Hayes Company is considering two capital investments. Both investments have an initial cost of \(10,000,000 and total net cash inflows of \)17,000,000 over 10 years. Hayes requires a 12% rate of return on this type of investment. Expected net cash inflows are as follows:

Year

Plan Alpha

Plan Beta

1

\( 1,700,000

\) 1,700,000

2

1,700,000

2,300,000

3

1,700,000

2,900,000

4

1,700,000

2,300,000

5

1,700,000

1,700,000

6

1,700,000

1,600,000

7

1,700,000

1,200,000

8

1,700,000

800,000

9

1,700,000

400,000

10

1,700,000

2,100,000

Total

\( 17,000,000

\) 17,000,000

Requirements

  1. Use Excel to compute the NPV and IRR of the two plans. Which plan, if any, should the company pursue?

  2. Explain the relationship between NPV and IRR. Based on this relationship and the company’s required rate of return, are your answers as expected in Requirement 1? Why or why not?

  3. After further negotiating, the company can now invest with an initial cost of $9,500,000 for both plans. Recalculate the NPV and IRR. Which plan, if any, should the company pursue?

Why is it preferable to receive cash sooner rather than later?
See all solutions

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