Principles of Corporate Finance_ 12th Edition

252 Part Three Best Practices in Capital Budgeting

bre44380_ch10_249-278.indd 252 09/30/15 12:45 PM

was undertaken. Postaudits pay off mainly by helping managers to do a better job when it

comes to the next round of investments. After a postaudit the controller may say, “We should

have anticipated the extra training required for production workers.” When the next proposal

arrives, training will get the attention it deserves.

Postaudits may not be able to measure all of a project’s costs and benefits. It may be impos-

sible to split the project away from the rest of the business. Suppose that you have just taken

over a trucking firm that operates a delivery service for local stores. You decide to improve

service by installing custom software to keep track of packages and to schedule trucks. You

also construct a dispatching center and buy five new diesel trucks. A year later you try a post-

audit of the investment in software. You verify that it is working properly and check actual

costs of purchase, installation, and operation against projections. But how do you identify the

incremental cash inflows? No one has kept records of the extra diesel fuel that would have

been used or the extra shipments that would have been lost absent the software. You may be

able to verify that service is better, but how much of the improvement comes from the new

trucks, how much from the dispatching center, and how much from the software? The only

meaningful measures of success are for the delivery business as a whole.

10-2 Sensitivity Analysis

Uncertainty means that more things can happen than will happen. Whenever you are con-

fronted with a cash-flow forecast, you should try to discover what else can happen.

Put yourself in the well-heeled shoes of the treasurer of the Otobai Company in Osaka,

Japan. You are considering the introduction of an electrically powered motor scooter for city

use. Your staff members have prepared the cash-flow forecasts shown in Table  10.1. Since

NPV is positive at the 10% opportunity cost of capital, it appears to be worth going ahead.

NPV = −15 + (^) ∑
t = 1
10
__^3
(1.10)t
= +¥3.43 billion
Before you decide, you want to delve into these forecasts and identify the key variables that
determine whether the project succeeds or fails. It turns out that the marketing department has
estimated revenue as follows:
Unit sales = new product’s share of market × size of scooter market
= .1 × 1 million = 100,000 scooters
❱ TABLE 10.1 Preliminary cash-flow
forecasts for Otobai’s electric scooter
project (figures in ¥ billions).
Assumptions:

1. Investment is depreciated over 10 years straight-line.


2. Income is taxed at a rate of 50%.

Investment

Revenue

Variable cost

Fixed cost

Depreciation

Pretax profit

Tax

Net profit

Operating cash flow

1 2 3 4 5 6 7 8

Net cash flow

Year 0 Years 1−10

37.5

30

3

1.5

3

1.5

1.5

3

3

15

• 15

BEYOND THE PAGE

mhhe.com/brealey12e

Try It! Scooter

project

spreadsheets