Corporate and Project Finance Modeling

Chapter 16Using Financial Models to Establish Break-Even Points for Key Input Variables with Data Tables

The value of a corporation comes from differentiation in cost structure, technological innovation, location, marketing strategy, and various other aspects of business strategy. In the long run, relative value does not generally arise because a company is better than its competitors in forecasting commodity prices, gross domestic product growth, trends in interest rates, or other economic variables. These variables to be sure do have important if not dramatic effects on value. But anybody who claims to differentiate their business by making superior forecasts of variables such as the oil price is arguably committing fraud. Instead of wasting time on consulting studies or marketing reports that attempt to forecast variables such as GDP growth or interest rates, you can use your financial models to compute break-even values for the economic variables that are difficult to forecast. Break-even analysis is similar to making a graph with a drop-down box discussed in Chapter 15. The subtle but important difference between methods introduced in this chapter and those discussed in Chapter 15 is that with break-even analysis you can quantify risk as a single number that represents the cushion or the distance from current levels that various different value drivers can move up or down before something really bad happens. Once you have this cushion defined you can use your judgment to ...