Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

This analysis shows the need to pay great attention to the forecasts of investment costs and sales. Anover-optimistic provision for sales can turn an unprofitable investment project into a profitable one: so, itis important to analyse the market dynamics and the company’s capacity to compete successfully.In order to properly assess the project risk, the risk analysis was based on an appropriate probabilitydistribution for the critical variables. In the sensitivity analysis the most critical variables identified were‘Sales of product C’ and ‘New equipment costs’.Table 4.60 Assumed probability distributions of the project variables, Monte Carlo methodVariable Applied to Range Kind of distribution NotesSales of product C Financial and economic 1,400–2,600 units Gaussian MV 104 = 2,000; SD = 180New equipment costs Financial and economic 38,000–46,000 Euro TriangularFigure 4.15 Probability distribution of sales of product C in Units – Normal distribution0,0025Probability density0,0020,00150,0010,000500,00 500,00 1000,00 1500,00 2000,00 2500,00 3000,00Values of the variableFigure 4.16 Probability distribution of new equipment costs in Euro – Triangular distribution0.000Probability density0.0000.0000.0000.0000.0000.00035,000.00 37,000.00 39,000.00 41,000.00 43,000.00 45,000.00 47,000.00Values of the variableThe results of the risk analysis (see Figure 4.17 below) show that the project is highly risky (more than40% probability of a negative ENPV). Given the modest financial return on investment and the high riskfor the economic return 105 , the project should be reconsidered and risk mitigation measures adopted.104105MV = Mean value; SD = Standard deviation.The risk is also relatively high for the private investor (the analysis is not reported here).192