Financial Analysis Techniques & Market Efficiency

Financial Analysis Techniques

Sensitivity Analysis

• Considers changes in variables, only one change in each simulation.
• Provides a tool to answer “what if” questions.
• By comparing changes in different variables, we can assess project risks and make decisions accordingly.

Scenario Analysis

• Considers changes in two or more variables simultaneously.
• Allows consideration of the best and worst-case scenarios.
• Requires a large number of simulations.
• By comparing different scenarios, we can assess project risks.

Break-Even Analysis

• The Break-Even point is the level of sales that offsets all costs.
• It can be calculated in terms of profit or cash flow.
• It must assume a certain sales mix if the product contributions are different.

Monte Carlo Simulation

• Statistical technique that considers all possible combinations of variables. The simulation results consider all possible outcomes, allowing assessment of the risks assumed in the investment project.
• Based on selecting random numbers for each variable.

Monte Carlo Simulation (II)

• Random numbers are generated by the computer, and the process is repeated many times, obtaining different outcomes so that the worst case, most likely, and best case can be predicted.

Decision Trees

• Investment projects are subject to change during their life due to certain “milestones.”
• The different outcomes of certain milestones in the project may condition the decisions taken and therefore change the result, affecting the project cash flows and its present value.

Financial Markets

Perfect Market

• Is frictionless.
• Perfect competition: in securities markets, it means that all participants are “price takers.”
• Information is costless and received simultaneously by all individuals.
• All individuals are rational and maximize their expected utility.

Efficient Market

• Prices fully and instantaneously reflect all available relevant information.
• If the market is totally efficient, there can be no positive NPV transactions.

Requirements:

1. Prices reflect all information contained in the record of past prices.
2. Prices reflect not only past prices but all other public information.
3. Prices are always fair, and no investor would be able to make consistently superior forecasts of stock prices.