corality - key driver analysis
DESCRIPTION
Dr Liam Bastick (Director of Corality, Melbourne) explained the central issue associated with model forecasting, and discussed three common approaches to risk evaluation, Strategic Options Analysis (SOA) and real options analysis.TRANSCRIPT
CoralityKey Driver AnalysisModelling
Agenda
Model forecasting: the issue
Standard approaches overview
Risk evaluation: three common approaches Scenarios
Sensitivities
Simulations
Strategic Options Analysis (SOA)
Real options analysis
We regularly build Excel spreadsheet
models based upon future
expectations and single point
estimates (see right)
You may have an inherent
appreciation of the role of uncertainty
within the model But often try to counter this by using
“expected” single-point values as a
proxy for a range
Add “contingency factors”
Sometimes they may even add a “risk
premium” to a discount rate when
evaluating NPVs
The actual full impact of uncertainty
(i.e. risk) is frequently not even
considered: uncertainty is not risk
The issue
…according to our financial model,
your sales in 2011 will be precisely
$17,499,521.66, which will mean
your company will be worth
exactly $77,378,255.44…
1. Scenarios
“Snapshot” technique: unlikely any given situation will actually occur
Scenarios are often used to generate “top down” views of the world. Several
variables are changed in order to simulate a particular situation (e.g. if
considering turnover, prices might be increased, but volumes reduced, etc.)
Often referred to as “worst-case”, “best-case” and “alternative” scenarios
Changing variables individually can be cumbersome, and in any cases, the
scenarios evaluated may be meaningless
Is your base case really the most likely / expected – one generally has no
idea of actual likelihood
Risk evaluation: three common approaches
2. Sensitivities
Sensitivities are usually used to
generate “bottom up” views of the world
Only one variable is changed so that its
influence on key output(s) can be
determined
Unrealistic technique
Two types of tornado: deterministic and
non-deterministic
Care required in interpretation
Risk evaluation: three common approaches
How tornados and worst-case scenarios
might combine in practice
Cu
mu
lati
ve P
rob
ab
ilit
y (
%)
10
20
30
40
50
60
70
80
90
100
Value(NPV — $ billions)
0
–2 -1 0 1 2 3 4
Status Quo
Rainbow
Bon Jovi
ABBA
3. Sensitivities
All assumptions to be considered varied at the same time
Interrelationships and correlations included
Can be time intensive, but very useful
Probabilistic approach
Risk evaluation: three common approaches
Business
assessment
Clear frame
Clearly defined
alternative
strategies
Quantitative
valuation of the
various alternative
strategies
Refined
alternative
business
plan
Stage Four:
Decide on
Strategic Options;
Lay out
business
plan
Stage Three:
Analyse and value
Strategic Options
Stage Two:
Develop
Strategic Options
Stage One:
Frame
Strategic Options
Go / No Go Go / No Go Go / No Go
Strategic Options Analysis
Net Present Value (NPV)
Supposedly considers shareholder objective, i.e. maximise value
In real world capital structure decisions, assists with minimising the cost of capital without impairing operating cash flows
Considers time value of money
Does not consider embedded options
Real options
Captures „non-traditional‟ issues, e.g. value to delay, expand or abandon
Recognises selecting projects with highest NPV may short change investments that offer a firm more flexibilityin operations and investing
Recognises minimising the cost of capital does not consider the value of financial flexibility that comes from having excess debt capacity
Real options
Thank you!
Sydney
Michael Michaelides
+61 2 9222 9222
Melbourne
Liam Bastick
+61 3 8610 6301