NPV
Net Present Value (NPV) should be calculated for every strategic alternative if possible. See my post 'NPV Tips and Template' for a complete discussion of how to approach the NPV calculation.
Financing Required vs. Financing Available
It is important to calculate and demonstrate whether there is enough financing available for the strategic alternatives.
Constraints Met
You should calculate whether your strategic alternatives meet the constraints provided in the case. (ie. bank covenants, capacity constraints, etc.. If you do not have time to calculate this for every strategic alternative, be sure that you do the calculation at least for the strategic alternative that you end up recommending.
Sensitivity Analysis
This is the easiest and quickest calculation and I always did this for at least one strategic alternative. What I do is calculate NPV for an alternative as usual, and then copy and paste this NPV two time. Then you end up with three sets of the same NPV - then, for the second and third NPV I would change my assumptions so that I would end up with the following set of three NPV calculations: conservative assumptions, optimistic assumptions and your normal/most likely assumptions. Make sure to tie this into the case via the analysis of the alternatives or in the recommendations.
Profitability Analysis
If there is no major investment for an alternative, I generally like to calculate profitability for 3-5 years. I show the after tax revenues vs expenses and identify whether the alternative generates a profit or loss through the years (don't forget to include any one time costs in the appropriate years).
Payback Period
This is my lease favorite quantitative tool but if you like, you may throw this one in as it doesnt usually take too much time to calculate. The payback period is calculated as follows:
Cost of the strategic alternative (cost of the investment)
Annual incremental after-tax cash inflows
Keep in mind that payback period ignores the time value of money and generally assumes that annual cash inflows are the same each year.
Re: Financing Required/Financing Available, in doing the Fleet case, there is financing required right away (initial investment) and then financing required the next two years after that (for the new cars). How would you handle that type of scenario? I know normally you do Financing Required/Financing Available for just the one time costs.
ReplyDeleteThey require a target net income for 2011, which can be determined and make choosing the alternatives quick easy. However, you would think this investment into the future would play a part (factored in)in choosing how many alternatives you can afford.
I like your suggestions. Would calculating Contribution Margin within an alternative be another good tool to "throw" in (even though you may not require it)?
I have not reviewed the fleet case - however, the way I would approach this would be to calculate financing required vs available based on initial investment only and within the alternative calculation i would show how the project finances the additional required capital once it is already operating.
ReplyDeleteMy rationale is that to start the project we need to use current funds, there is no time to earn more, but for costs in subsequent years once the project is up and running, those additional costs can already be financed by the project's cash flows or other sources of funds that can be negotiated/obtained in the future.
To me the calculation of financing required vs available is like asking yourself 'how much do i have now and what can i afford to buy now'. Costs in subsequent years will be funded not by current available financing but by some future financing sources... hence why I only include initial investment when I do the financing required vs available. Does this make sense to you?
If you can easily calculate CM and then tie it in effectively into the case, then go for it, otherwise if you need to spend a lot of time on it or if you cannot tie it into the case, I would not worry about it too much (unless the case actually requires you to touch on CM, perhaps through a constraint or a target).