Expected net present value

The top line of the index is an expected net present value which takes account of the sequential nature of the decision-making process and thus captures (unlike indices based on totals only) the value of the option to abandon given technical failure which the developer holds. (Note that this option is not held if the stages are done in parallel.) The bottom line is used to scale projects according to their investment requirements. 

Extensions of these measures to uncertain future conditions have been made, especially in the form of expected net present value. Another problem with all measures is the uncertainty of how long the plant will be in operation, at what point preventive maintenance will be intensified, or when some revamps will take place. In the old days, all these difficulties were ignored because of the inability or, actually, the lack of knowledge of how to handle uncertainty beyond a simple and reduced set of scenarios. In other words, the model was simplified for two reasons an engineer should be able to do calculations and uncertainty was too complex to handle. The excuse is not valid anymore. 

Risk premium Applequist etal. (2000) suggest benchmarking new investments against the historical risk premium mark. Thus, they propose a two-objective problem, where the expected net present value and the risk premium are both maximized. The technique relies on using the variance as a measure of variability and therefore it penal-izes/rewards scenarios at both sides of the mean equally, which is the same limitation that is discussed above. 

A certain investment, if purchased, will result in annual operating savings described by the probability distribution shown in column (b) of Table 12. The project life is described by the probability distribution shown in column (e), and the initial cost is a normally distributed random variable with pu = 25,000 and a = 1000. The discount rate to be used in the analysis, a certainty estimate, is 0.10. It is assumed that the annual savings, project life, and initial cost are independent random variables. If there are no other relevant consequences of the proposed investment, the expected net present value is given by the equation... 

The Norwegian regulator, NVE, has in their regulations given incentives for the companies to minimise the expected net present value of the following cost elements (NVE 2007) ... 

ABSTRACT The increased use of wireless networks in schools has created concern among many parents and scientists is the low levels microwave radiation emitted by the transmitters harmful The scientific community does not provide a clear answer, there are uncertainties about the consequences of the radiation. This has raised the issue of applying the precautionary principle and switch off the wireless networks and use a safer alternative, for example a cable system. However, the decision-makers argue that the uncertainties and the risk need to be balanced with the benefits of the activity. Some type of cost-benefit analysis is required. But it is not obvious how such an analysis should he performed in a case like this, and the purpose of this paper is to present and discuss two possible approaches, one based on willingness to pay and one based on expected net present value calculations. 

In the paper we compare this approach with a standard cost-benefit analysis (CBA) based on expected net present value (E[NPV]) calculations, reflecting the decision-maker s WTP. Using the CBA the expected benefits need to be determined and the decision-maker must specify the value of improved health effects. According to this approach the activity is beneficial when its expected net present value is positive (Fuguitt etal. 1999). 

From this analysis expected net present value calculations are computed as well as crude imcertainty intervals for the actual net present values NPV. The intervals are generated hy Monte Carlo simulation, based on probabihty distributions (triangular) for the various categories of N. It is distinguished between three scenarios it turns out that the effects of wireless networks are severe (probabihty pi), moderate (probability p2) and small (probabihty P3). The results are shown as a function of different values of the probabilities p. 

The stochastic problem is characterised by two essential features the uncertainty in the problem data and the sequence of decisions. In our case, the demand is considered as a random variable with a certain probability distribution. The binary variables associated to the opening of a plant/warehouse as well as the continuous variables that represent the capacity of plants/warehouses are considered as first stage decisions. The fluxes of materials and the sales of products are taken as second stage or recourse variables. The objective hinctions are therefore the expected net present value and the expected consumer satisfaction. 

Figures 4 depicts the financial risk curves associated with each point of the Pareto Optimal curve. For example the curve with no restriction on the consumer satis ction (SP E(CSAT)>0) is the one with largest expected NPV. As the consumer satisftiction is constrained the curves move to the left, thus reducing the expected net present value. The shape of the curves, however, remains fairly constant. The corresponding curves of consumer satisfaction risks are shown in Figure 3. The curves move to the right as the expected net present value is reduced. The shape in this case becomes steeper.

In this case it might also be interesting to consider protecting measures to reduce the risk, for instance in case the Algerian military forces fail to prevent terrorist attacks. It is common to use cost-benefit type of analysis based on the Expected Net Present Value formula (E[NPV]), to say something about Implied Cost Per Averted Fatality (ICAF)... 

Keywords economic model, shareholder s profit, project cashflow, gross revenue, discounted cashflow, opex, capex, technical cost, tax, royalty, oil price, marker crude, capital allowance, discount rate, profitability indicators, net present value, rate of return, screening, ranking, expected monetary value, exploration decision making. 

Numerical Measures of Risk Without risk and the reward for successfully accepting risk, there would be no business activity. In estimating the probabilities of attaining various levels of net present value (NPV) and discounted-cash-flow rate of return (DCFRR), there was a spread in the possible values of (NPV) and (DCFRR). A number of methods have been suggested for assessing risks and rewards to be expected from projects. 

Let us consider a proposed project in which there is a probability pi that a net present value (NPV)i wih result, a probability p2 that (NPV)2 will result, etc. A weighted average (NPV),, known as the expected value, can then be calculated from... 

The same questions may then be asked for different values of the probabilities p and po. The answers to these questions can give an indication of the importance to the company of P at various levels of risk and are used to plot the utility curve in Fig. 9-25. Positive values are the amounts of money that the company would accept in order to forgo participation. Negative values are the amounts the company woiild pay in order to avoid participation. Only when the utihty value and the expected value (i.e., the straight line in Fig. 9-25) are the same can net present value (NPV) and discounted-cash-flow rate of return (DCFRR) be justified as investment criteria. 

Example 13 Evaluation of Investment Priorities Using Prob-ability Calculations A company is considering investment in one or more of three projects, A, B, and C. We wish to evaluate the investment priorities if the prohahihties of attaining various net present values (NPV) are as listed in the third column of Table 9-11. Equation (9-105) gives the expected value for (NPV),. Hence for project A, (NPV), is computed from the data in Table 9-12 and found to be... 

Capital investment decisions are best made within the context of a life-cycle cost analysis. Life-cycle cost analysis focuses on the costs incurred over the life of the investment, assuming only candidate investments are considered that meet minimally acceptable performance standards in terms of the non-inonetary impacts of the investment. Using life-cycle analysis, the capital investment decision takes into account not just the initial acquisition or purchase cost, but maintenance, energy use, the expected life of the investment, and the opportunity cost of capital. When revenue considerations are prominent, an alternative method of analysis such as net benefit or net present value may be preferred. 

Both methods assume that the money earned can be reinvested at the nominal interest rate. Suppose the rates of return calculated are after tax returns and the company is generally earning a 5% or 6% return on investment. Is it reasonable to expect that all profits can be reinvested at 23% or even 20% No, it isn t Yet this is what is assumed in the Rate of Return method. Sometimes the rate of return may be as high as 50%, while a reasonable interest rate is less than 15%. Therefore if a reasonable value for the interest rate has been chosen (this is discussed later in this chapter) and the two methods differ, the results indicated by the Net Present Value method should be accepted. 

Optimization techniques are procedures to make something better. Some criteria must be established to determine whether something is better. The single criterion that determines the best among a number of alternatives is referred to as the performance index or the objective function. Economically, this is the expected profit for a plant design. It may be expressed as the net present value of the project. 

The project portfolio enables an overview on the ongoing research activities. Numerous economic and technical parameters have been proposed to provide a meaningful picture. Examples are attractiveness, strategic fit, innovation, gross/net present value, expected profits, R D expenditures, development stage, probability of success, technology fit, and realization time. Most of these parameters cannot be determined quantitatively, at least during the early phases of a project. 

If the goal of the buy-out price is to mimic what would have happened under best-case competitive market conditions, then the price should be based on expected profits rather than sales or costs. Ganslandt, Maskus, and Wong (2001) used cost data to calculate the buy-out, which rewards effort rather than success. Gross sales are certainly an element of pharmaceutical appropriation, but the relevant market metrics are the net present value (NPV) of the cash flow or the NPV of the profit stream. The purpose of the buy-out price should be to restore the expected profits, and more particularly, the lost R D cost recovery. 

The levelized PV electricity and H2 prices presented in this study are derived from Eq. 6 by choosing the electricity or H2 price level for the revenue component that produces a zero net present value for the net cash flow streams over the invest ment period, which in this case is equivalent to the internal rate of return. The esti mation of levelized PV electricity and H2 prices by the net present value cash flow method insures that all creditors and shareholders receive their expected rates of return. 

For this study it is assumed that the effect of inflation will be the same for cash inflows and outflows and rates of return. This inflation assumption implies that the inflation factor in Eq. 2 is the same in both the numerator and denominator, and hence, cancels out. Therefore, the net present value is both a nominal and real value. However, if the expected inflation rate for cash inflows, cash outflows, or rates of return are different, then inflation factors need to be added to the appropriate factors in Eq. 2 or equivalently in Eq. 6. 

The reward criterion covers those areas related to the expected financial performance of the project. An important method for determining the financial success of a project is the net present value (NPV) calculation. This method calculates the present value of future cash flows. If the NPV is positive, the investment is beneficial from a financial standpoint. Additionally, a financially successful project is expected to have an average return on capital employed (ROCE) above a selected level, which makes commercial sense with regards to industry/branch standards. 

The project team must detail all past costs that the project has incurred since its inception (start of EvP) on an annual basis. In addition, an annual project financial information table (ProFIT) data sheet should be presented. This sheet contains the revenue and cost forecasts for the upcoming ten-year period. It computes net present value (NPV) of future cash flows and return on capital employed (ROCE) automatically. At this stage, the team is expected to include detailed production costs data as well as estimates of plant costs (based on an engineering estimate, for example). The ten-year projection should be provided for three scenarios base, optimistic, and pessimistic. These cases are not meant to be simple percentage changes of the sales projections. Instead, the team should try to identify the drivers of the project s success and construct alternatives for the future that lead to different results for the project. The base case should be the most likely case. The optimistic scenario should be based on the positive development of some (not all) key success factors. The pessimistic scenario is usually the minimum feasible case, meaning a situation where the organization would still prusue the project, but some factors do not develop in a positive way. 

The fundamental value of a company, on the other hand, is the net present value of the expected future cash flows, discounted by the cost of capital (DCF). This only alters for the better or the worse if fundamental changes occur, for example if prices change, new technologies are introduced or the company achieves a breakthrough into new markets. 

Table 4-6 shows the NPV of the net returns in the years following market approval (in 1990 dollars) under the base case. The NCEs of 1981-83 deliver cash flows equal to net present value of 341 million per compound. After taxes, the present value in the year of FDA approval of this net revenue is reduced to approximately 230 million. These net revenues must be compared with the present value of the investment in R D required to discover and develop the compounds. An upper bound on the fully capitalized R D costs is about 359 million before tax savings, or 194 million after tax savings are considered (see table 3-10 in chapter 3). Thus, under the base-case scenario, on average, each compound can be expected to return a net present value of at least 36 million more (after taxes) than would be required to bring forth the investment in the R D. 

How does the cost of capital affect decisions to invest in R D projects To assess whether the investment is worth its 10 million R D cost, company managers (on behalf of their investors) would compute the net present value (NPV) of the investment by converting all future expected cash flows (both into and out of the firm) into their present value at the time the investment decision is made using the cost of capital appropriate to the project as the discount rate." The algebraic sum of the present values of all the expected cash flows is the NPV of the investment. If the NPV is greater than zero, the investment is worth it and will compensate investors at a rate of return that exceeds the cost of capital. 

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