Corporate Finance

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Corporate Finance

Step 1

Construct an ‘uncertainty profile’ for each key input factor like market size, market share, price per unit,
selling costs, variable costs, etc. The uncertainty profile is constructed by attaching probability of occurrence
to different values it can take on. The profile has probability on Y-axis and values of factor on the X-axis. For
instance, let us suppose, the price can take any value ranging from Rs 30 to Rs 50. Let us further suppose
there is a 5 percent chance of the realized price being Rs 30, a 10 percent chance of the price being Rs 35, a
20 percent chance of the price being Rs 40... and so on. The uncertainty profile for the price factor could be
constructed as shown in Exhibit 11.7 (page 233). The probabilities are set subjectively based on expert
opinion and past experience. Uncertainty profiles are constructed for all key factors similarly.

Exhibit 11.8 Uncertainty profile

10 20 30 40 50 60 70

Probability percent

30

25

20

15

10

5

Price Rs

Step 2

One value is chosen from each of the profiles randomly and combined to compute NPV, or IRR.

Step 3

The process is repeated several hundred times. Each time NPV and IRR are noted.

Step 4

Each result is listed from highest to lowest and the percentage of total situations falling within a given range
of NPV or IRR is determined as shown below:

Percentage of situations
= probability of Cumulative
NPV Range (Rs) occurrence (percent) probability (percent)

150,000–200,000 28 28
100,000–150,000 14 42
50,000–100,000 21 63
0–50,000 16 79
–50,000–0 21 100