Ockham 1 0 – Sensitivity Analysis Tool
- Ockham 1 0 – Sensitivity Analysis Tool Free
- Ockham 1 0 – Sensitivity Analysis Tool
- Ockham 1 0 – Sensitivity Analysis Tool Online
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Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?
NPV solution for Ockham Technologies (A): Building the Team case study
At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ockham Technologies (A): Building the Team case study is a Harvard Business School (HBR) case study written by Noam Wasserman. The Ockham Technologies (A): Building the Team (referred as “Ockham Assembling” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, IT, Negotiations, Operations management, Venture capital.
The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.
Lower limit = 1 / ARR lower limit (rounded to 0 decimal places) Upper limit = 1 / ARR upper limit (rounded to 0 decimal places) References. For full references, see the Credits & References section. Wilson (1927) 95% confidence interval for sensitivity, specificity, PPV and NPV Newcombe (1998a) 95% confidence interval for sensitivity. Sensitivity Analysis - A tools and Techniques Sensitivity analysis helps to determine which risks have the most potential impact on the project or program or portfolio. It takes into account two-variable at a time, they are Influencing variable and Dependent variable.
NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment
Case Description of Ockham Technologies (A): Building the Team Case Study
Describes the issues facing a founder-ceo regarding building a board, assembling an executive team, managing tension between co-founders, and outsourcing development work.
Case Authors : Noam Wasserman
Topic : Innovation & Entrepreneurship
Related Areas : IT, Negotiations, Operations management, Venture capital
Calculating Net Present Value (NPV) at 6% for Ockham Technologies (A): Building the Team Case Study
| Years | Cash Flow | Net Cash Flow | Cumulative Cash Flow | Discount Rate @ 6 % | Discounted Cash Flows |
|---|---|---|---|---|---|
| Year 0 | (10014766) | -10014766 | - | - | |
| Year 1 | 3444038 | -6570728 | 3444038 | 0.9434 | 3249092 |
| Year 2 | 3967196 | -2603532 | 7411234 | 0.89 | 3530790 |
| Year 3 | 3960829 | 1357297 | 11372063 | 0.8396 | 3325588 |
| Year 4 | 3229794 | 4587091 | 14601857 | 0.7921 | 2558299 |
| TOTAL | 14601857 | 12663771 |
The Net Present Value at 6% discount rate is 2649005
In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -
Different methods of capital budgeting
What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.
Capital Budgeting Approaches
Methods of Capital Budgeting
There are four types of capital budgeting techniques that are widely used in the corporate world –
1. Payback Period
2. Net Present Value
3. Profitability Index
4. Internal Rate of Return
Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.
Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –
1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Ockham Assembling shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Ockham Assembling have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
Formula and Steps to Calculate Net Present Value (NPV) of Ockham Technologies (A): Building the Team
NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0
Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.
Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project
Why Innovation & Entrepreneurship Managers need to know Financial Tools such as Net Present Value (NPV)?
In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Ockham Assembling often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.
To overcome such scenarios managers at Ockham Assembling needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.
Calculating Net Present Value (NPV) at 15%
After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.
| Years | Cash Flow | Net Cash Flow | Cumulative Cash Flow | Discount Rate @ 15 % | Discounted Cash Flows |
|---|---|---|---|---|---|
| Year 0 | (10014766) | -10014766 | - | - | |
| Year 1 | 3444038 | -6570728 | 3444038 | 0.8696 | 2994816 |
| Year 2 | 3967196 | -2603532 | 7411234 | 0.7561 | 2999770 |
| Year 3 | 3960829 | 1357297 | 11372063 | 0.6575 | 2604309 |
| Year 4 | 3229794 | 4587091 | 14601857 | 0.5718 | 1846645 |
| TOTAL | 10445540 |
The Net NPV after 4 years is 430774
(10445540 - 10014766 )
Calculating Net Present Value (NPV) at 20%
If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.
| Years | Cash Flow | Net Cash Flow | Cumulative Cash Flow | Discount Rate @ 20 % | Discounted Cash Flows |
|---|---|---|---|---|---|
| Year 0 | (10014766) | -10014766 | - | - | |
| Year 1 | 3444038 | -6570728 | 3444038 | 0.8333 | 2870032 |
| Year 2 | 3967196 | -2603532 | 7411234 | 0.6944 | 2754997 |
| Year 3 | 3960829 | 1357297 | 11372063 | 0.5787 | 2292146 |
| Year 4 | 3229794 | 4587091 | 14601857 | 0.4823 | 1557578 |
| TOTAL | 9474753 |
The Net NPV after 4 years is -540013
At 20% discount rate the NPV is negative (9474753 - 10014766 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ockham Assembling to discount cash flow at lower discount rates such as 15%.
Acceptance Criteria of a Project based on NPV
Simplest Approach – If the investment project of Ockham Assembling has a NPV value higher than Zero then finance managers at Ockham Assembling can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.
In theory if the required rate of return or discount rate is chosen correctly by finance managers at Ockham Assembling, then the stock price of the Ockham Assembling should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.
In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.
Sensitivity Analysis
Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Ockham Assembling should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –
What can impact the cash flow of the project.
Understanding of risks involved in the project.
What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.
What will be a multi year spillover effect of various taxation regulations.
Ockham 1 0 – Sensitivity Analysis Tool Free
What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.
Some of the assumptions while using the Discounted Cash Flow Methods –
Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.
Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.
References & Further Readings
Noam Wasserman (2018), 'Ockham Technologies (A): Building the Team Harvard Business Review Case Study. Published by HBR Publications.
| Sensitivity Analysis Example 1 | Calculation of the sensitivity of the results with respect to the modelparameters using forward sensitivity analysis method. |
| Sensitivity Analysis Example 2 | The local derivative-based sensitivity analysis method. |
| Sensitivity Analysis Example 3 | The global screening (Morris) and variance-based sensitivity analysismethods (FAST, Sobol) available in the SALib python software. |
Ockham 1 0 – Sensitivity Analysis Tool
8.6.1. Sensitivity Analysis Example 1¶
This tutorial illustrates calculation of the sensitivity of the results with respectto the model parameters using forward sensitivity analysis method in DAE Tools.
This model has one state variable (T) and one degree of freedom (Qin).Qin is set as a parameter for sensitivity analysis.
The integration of sensitivities per specified parameters is enabled and the sensitivities can be reported to the data reporter like any ordinary variable by setting the boolean property simulation.ReportSensitivities to True.
Raw sensitivity matrices can be saved into a specified directory using the simulation.SensitivityDataDirectory property (before a call to Initialize).The sensitivity matrics are saved in .mmx coordinate format where the firstdimensions is Nparameters and second Nvariables: S[Np, Nvars].
The plot of the sensitivity of T per Qin:
Files
| Model report | tutorial_sa_1.xml |
| Runtime model report | tutorial_sa_1-rt.xml |
| Source code | tutorial_sa_1.py |
8.6.2. Sensitivity Analysis Example 2¶
Ockham 1 0 – Sensitivity Analysis Tool Online
This tutorial illustrates the local derivative-based sensitivity analysis method available in DAE Tools.
The problem is adopted from the section 2.1 of the following article:
- A. Saltelli, M. Ratto, S. Tarantola, F. Campolongo.Sensitivity Analysis for Chemical Models. Chem. Rev. (2005), 105(7):2811-2828.doi:10.1021/cr040659d
The model is very simple and describes a simple reversible chemical reaction A <-> B, with reaction rates k1 and k_1 for the direct and inverse reactions, respectively.The reaction rates are uncertain and are described by continuous random variables with known probability density functions. The standard deviation is 0.3 for k1 and1 for k_1. The standard deviation of the concentration of the species A isapproximated using the following expression defined in the article:
The following derivative-based measures are used in the article:
Derivatives dCa/dk1 and dCa/dk_1 calculated using the forward sensitivity method
Sigma normalised derivatives:
The plot of the concentrations, derivatives and sigma normalised derivatives:
Files
Ockham 1 0 – Sensitivity Analysis Tool Download
| Model report | tutorial_sa_2.xml |
| Runtime model report | tutorial_sa_2-rt.xml |
| Source code | tutorial_sa_2.py |
8.6.3. Sensitivity Analysis Example 3¶
This tutorial illustrates the global variance-based sensitivity analysis methodsavailable in the SALib python library.
The problem is adopted from the section 2.6 of the following article:
- A. Saltelli, M. Ratto, S. Tarantola, F. Campolongo.Sensitivity Analysis for Chemical Models. Chem. Rev. (2005), 105(7):2811-2828.doi:10.1021/cr040659d
The model describes a thermal analysis of a batch reactor, with exothermic reaction A -> B. The model equations are written in dimensionless form.
Three global sensitivity analysis methods available in SALib are applied:
- Morris (Elementary Effect/Screening method)
- Sobol (Variance-based methods)
- FAST (Variance-based methods)
Results from the sensitivity analysis:
The scatter plot for the Morris method:
The scatter plot for the Sobol method:
The scatter plot for the FAST method:
Files
| Model report | tutorial_sa_3.xml |
| Runtime model report | tutorial_sa_3-rt.xml |
| Source code | tutorial_sa_3.py |