Sensitivity to one or more investments in DCF Analysis with Uncertainty

Maria Balatbat
University of New South Wales
Australia

David Carmichael
University of New South Wales
Australia

Abstract:
Conventional discounted cash flow (DCF) analysis is carried out on the assumption that predicted cash flows are deterministic. Feasibility is defined against measures such as a deterministic present worth, and multiple project investments add no extra complications over single investments. Determinism is conventionally assumed even though the presence of uncertainty and an inability to predict cash flows precisely is widely acknowledged. The paper shows that when cash flow uncertainty is introduced, the definition of what is a feasible investment is no longer clear cut; it is no longer determined by one transition value, but rather is shown to take on different values over the time horizon of a project. The paper also shows that, with more than one project investment, there are multiple possibilities and extra complications. The paper examines the sensitivity of investments, in a present worth sense, to the various ways that multiple project investments can be viewed, in particular multiple project investments occurring at differing points in time and in different combinations. The formulation presented in the paper is supported with a case example. The paper provides interesting insight into feasibility calculations, and will be of use to practitioners engaged in front-end project work, especially those looking at project investment risk. The paper is an original contribution on two fronts - the time-variability of feasibility, and combinations of multiple project investments.