W12_Austin_Evaluating Housing Estate Development Projects using Breakeven & Sensitivity Analysis

1.    Problem recognition, definition and evaluation

This week case study is to evaluate the non-probabilistic techniques for dealing with risk and uncertainties associated with Housing Estates Development Projects in Nigeria and determine investment decisions under uncertainty and risk situations.

2.    Development of the feasible alternatives

Some of the methods used for investment decisions under uncertainty and risk situations includes; Break-even Analysis, Spider Graph and Tornado Chart.

1.    Break-even Analysis – Breakeven analysis determines the value of a critical factor at which economic trade-offs are balance. When the selection between mutually exclusive housing projects alternatives (or outcomes) is heavily dependent on a single value basis for selection, which is known as the breakeven point, where return on investment (or annual savings) offsets initial investment costs.

2.    Spider Graph – This approach makes explicit the impact of variability in the estimates of each factor of concern on the economic measure of merit. The table below demonstrates this technique by plotting the results of changes in the estimates of several factors, separately, on the PW (Present Worth) of the Housing Estate Development projects.

3.    Tornado Chart – It’s a bar chart commonly used to compare characteristics of mutually exclusive alternatives defined as a group of projects from which, at most, one project may be selected. It helps visualize investment risks and uncertainties, such as; Budget availability, Timely delivery, Quality, Standard and Strategy.

3.    Development of the outcomes and cash flows for each Alternative

a.    Using breakeven chart for the feasible alternatives dependent on a function of their location. Consider a housing development projects (50 units of three bed-rooms each), mutually exclusive and comparably located as shown below:

To find the breakeven point for the selection of the mutually exclusive housing estates development projects alternatives (outcomes), where Return on Investment (annual savings), offsets Initial Investment.

In this case study, we develop Equivalent Uniform Annual Cost (EUAC) expressions for each of the housing estate development project location.

Assume minimum attractive rate of return (MARR) = 15% and a study period of 10 years. By default, we also assume the maintenance costs of the housing estates development alternatives (outcomes) as well as the future resale value will be the same.

Hence, the breakeven points, using the EUAC metrics is as follows;

EAUC (15%) = Initial investment (A/P, 15%, 10) + Annual maintenance + Annual Rate of Return:

Thus for Location A:  EAUC (15%) = 20,000 (A/P, 15%, 10) + 70% = 24,012

Thus for Location B:  EAUC (15%) = 15,000 (A/P, 15%, 10) + 60% = 16,219

Thus for Location C:  EAUC (15%) = 10,000 (A/P, 15%, 10) + 50% = 12,323 Based on the best estimates of the average Returns on Investment (annual savings) with MARR = 15% and a study period of 10 years, Housing development project with the lowest cost or greatest savings should be given the highest priority. a.    Using Spider Graph to determine how sensitive the decision to invest in the housing estates development projects, dependent on the estimates of investment costs and returns on investments (annual savings).  With reference to Sensitivity Analysis using Spider Graph on P.484 EE a.    Using Tornado Chart to examine possible cash flows and returns on an investment when one uncertain element is altered. It helps visualize investment risks and uncertainties, such as; Budget availability, Timely delivery, Quality, Standard and Strategy: As shown above, the varying NPVs of a housing estate development project, dependent on an initial investment valued at $8 billion (the point where the vertical axis crosses), subject to uncertainties.  In this case study, Budget availability is the largest uncertainty; with 25% uncertainty, the project’s NPV would drop to N4 billion, from the base case of N8 billion. On the other hand, if uncertainties increase to 35%, we have a large upside and the NPV would be N12 billion. However, If it goes down to 20,500 the NPV would reduce to N5 billion. However, if we can raise budget up to 29,500 due to a favourable competitive environment, then the upside is N4 billion from the base case. 1.    Selection of the acceptable criteria In our estimates of the average Returns on Investment (annual savings) with MARR = 15% and a study period of 10 years, Housing development project with the lowest cost or greatest savings should be given the highest priority, as shown in the breakeven analysis. The sensitivity of the decision to invest in the housing estates development projects is dependent on the estimates of investment costs and returns on investments (annual savings), as depicted in the spider graph. Possible cash flows and returns on investment are dependent on the degree of alteration or variation of one uncertain element or risk impact, as illustrated with the tornado chart. 5. Analysis and Comparison of feasible alternatives Based on above analysis, our best estimates of the average Returns on Investment (annual savings) with MARR = 15% and a study period of 10 years, Housing development project with the lowest cost or greatest savings should be given the highest priority in the following order of preference: ·         Project Location A ·         Project Location B ·         Project Location C 6.    Selection of the preferred alternative Based on our best estimates of the average Returns on Investment with MARR = 15% and a study period of 10 years, Housing development project location A is found to be more economical, with favourable Returns on Investment. 7.    Performance Monitoring and Post Evaluation of Results Performance monitoring and post evaluation of results using sensitivity analysis shall be based on best estimates of investment costs and returns on investments (annual savings). Having looked at the marginality of feasible alternatives, the management best choice of Housing development project shall be determined by the lowest cost and greatest savings, starting from Project Location A, with favourable returns on investment. 8.    References/Bibliography 1.    Sullivan, W. G. Wicks, E.M., & Koelling, C.P. (2012). Engineering Economy, (15th ed.)  [Chap. 11, PP473 – PP499]. Breakeven and Sensitivity Analysis http://www.amazon.com/Engineering-Economy-15th-William-ullivan/dp/0132554909 2.    W22_TRI_ Sensitivity Analysis on Selected Gas Project http://aacemahakam.blogspot.com/2012/12/w22tri-sensitivity-analysis-on-selected.html 3.    Jovanović, P. J. (1999) International Journal of Project Management, Evaluation of investment projects under uncertainty and risk is possible to be carried out through. Sensitivity Analysis of criteria for investment project evaluation is a very complex procedure. Application of sensitivity analysis in investment project evaluation under uncertainty and risk 4.    Méndez-García, J. C. (1 Feb 2007). Tornado Charts in Excel 2007 Update.  A tornado diagram, as discussed in a previous entry, may provide a ... You've visited this page 2 times. Last visit: 1/7/13 http://8020world.com/2007/02/easy-creation-of-tornado-charts-in-excel-5-steps-no-add-ins/ 5.    A spider chart is a graphical method of displaying multivariate data in the form of a two-dimensional chart of three or more quantitative variables represented on ... http://demos.dojotoolkit.org/demos/spiderChart/demo.html