using monte carlo stimulation model to analyze investment project risk of expanding a new childrens fashion product line for mothercare joint stock company

LIST OF THE TABLESTable 1: The table shows the company''''s sales revenue Figure 1: The figure shows the project’s annual net cash flow Figure 2: The figure shows the fluctuations of NPV ac

INDIVIDUAL ASSIGNMENT REPORT

QUANTITATIVE FINANCE

Topic: Using Monte Carlo Stimulation model to analyze investment project risk of expanding a new children's fashion product line for Mothercare Joint Stock Company

Lecturer: Ph.D Huynh Thi Cam Ha

Course ID: 23C1FIN50505102

Student Name: Nguyen Thuy To Quyen

Class – School Year: FNC02 – K47

TABLE OF CONTENTS

LIST OF THE TABLES……… 1

CHAPTER 1: INTRODUCTION1.1 The Monte Carlo simulation model ……… 5

1.2 The investment project ……… 5

1.3 Summary of investment project……… 8

CHAPTER 2: PROJECT INVESTMENT ANALYSIS2.1 Weighted Average Cost of Capital (WACC)……… 9

2.2 The project's annual net cash flow……… 9

2.3 Project assessment………10

2.4 Analyze fluctuations in NPV using Data Table……… 11

2.5 The risk estimation of the investment project using Monte Carlo simulation model……… 14

CHAPTER 3: CONCLUSION AND RECOMMENDATION3.1 Conclusions……… 19

3.2 Recommendations……… 20

REFERENCES……….23

1

LIST OF THE TABLES

Table 1: The table shows the company's sales revenue

Figure 1: The figure shows the project’s annual net cash flow

Figure 2: The figure shows the fluctuations of NPV according to WACC

Figure 3: The figure shows the fluctuations of NPV according to the quantity

Figure 4: The figure shows the fluctuations of NPV according to the quantity andprice

Figure 5: The figure shows the distribution of Demand function

Figure 6: The figure shows the project’s annual net cash flow with negative NPV

3

Too long to read onyour phone? Save

to read later onyour computer

Save to a Studylist

Figure 7: The figure shows the list of 100 simulated values of NPV

Figure 8: The figure shows the NPV descriptive statistics

Figure 9: The figure shows the NPV results distribution chart

Figure 10: The figure shows the probability of NPV<1,000,000,000

CHAPTER 1: INTRODUCTION

Currently, in the context of strong international integration and globalization,businesses have to make even more efforts to create more "value" for theirorganizations Vietnam's economy is in the development stage and attracts domesticand foreign investment, investment projects bring long-term profits However, anyinvestment project always comes with risks Analyzing, simulating risks, and planningto minimize risks along with investment project plans is an indispensable andimportant job Because the risks are often unpredictable, causing harm to the projectand corporate finances and causing waste of human resources and resources

In this research, we will “Use the Monte Carlo simulation model to analyze

investment project risk” Thereby, based on available information, analyze project

risks and propose options to minimize risks

1.1 The Monte Carlo simulation model:

A Monte Carlo simulation is used to model the probability of differentoutcomes in a process that cannot easily be predicted due to the intervention ofrandom variables It is a technique used to understand the impact of risk anduncertainty A Monte Carlo simulation is applied in numerous domains such asfinance, business, engineering, and physics to address a variety of issues It issometimes called a multiple probability simulation

Monte Carlo analysis is a method used to predict the impact of risk conjecturesby running simulations to determine the range of possible outcomes for variousscenarios It involves random sampling using uncertain risk-transforming inputs togenerate a range of outcomes with a confidence measure This technique aids inmaking project decisions by forecasting the likely outcome of an event

1.2 The investment project:1.2.1 Company overview:

With four years of expertise, Mothercare Joint Stock Company specializes inoffering products for pregnant mothers and newborns The company's field of activityis to develop retail chain systems for pregnant mothers and babies These systemsinclude: Products for moms and babies (milk bottles, breast pump, milk warmer andsterilizer); Toys and Educational materials for kids; and Newborn clothing rangingfrom 0-12 months In 2024, to expand its business market share, Mothercare JSC

plans to invest in a new fashion product line for boys and girls from 1-5 years old.

5

1.2.2 Project objectives and basis:

The children's fashion market in Vietnam has extremely wide developmentpotential According to a report by Mordor Intelligence, by 2023, the children'sclothing market size is estimated to reach 258.35 million USD, and is expected toreach 335.26 million USD by 2028, growing at a rapid rate CAGR is 5.35% in theperiod 2023 - 2028

The children's fashion market is one of the most potential and profitablemarkets in the garment industry The children's fashion market's retail value growth isexpected to surpass both the men's and women's fashion markets due to a combinationof factors such as demographics, social trends,

1.2.3 Initial fixed asset investment:

To implement the project, the company plans to invest 6,000,000,000 VND forthe following categories:

- Garment factory, warehouse and expanding business premises- Production line includes machinery and equipment

- Means of transportationAt the end of year 6, the fixed asset will be sold (liquidated) with a pre-taxvalue of 1,000,000,000 VND

1.2.5 Net Working Capital:

The project requires an initial investment in net working capital (NWC) of800,000,000 VND, and NWC will be recovered by the end of the project's life

1.2.6 Variable cost:

For simplicity, in addition to management costs and fixed costs (rent, taxes,salaries, ), the remaining operating costs below are expected to be variable costsbased on revenue:

- Raw material costs- Direct labor costs- Energy costs for production- Packaging costs

- Sales commissionFrom there, operating costs (excluding depreciation) are estimated to accountfor 30% of revenue

1.2.7 Quantity:

The company estimates that the sales volume at the end of the first year will be9,000 units The output in the following years increases according to the law ofarithmetic progression, with a difference of 1,000 products

1.2.8 Sale price:

The company is targeting the mid-range to high-end market segment for itschildren's fashion product line, which caters to children aged 1 to 5 The market pricesfor these products in this segment at Vietnamese children's clothing brands:

- Zara Kids: 169,000 - 749,000 VND- H&M Kids: Under 500,000 VND- Lullaby: 199,000 - 499,000 VND- Rabity: 100,000 - 299,000 VND

The company relies on the segment and market price for children's fashion inVietnam as well as production costs At the end of the first year, the company sets aselling price of 280,000 VND, which increases by 6% annually in the following years

1.2.9 The capital structure of the project:

The initial cost of the project was mobilized from 2 funding sources:- Equity for 70% with a cost of equity of 16%

- The project is supported by preferential capital from Saigon - HanoiCommercial Joint Stock Bank With a loan amount of 30% of the totalinvestment capital of the project with a 6-year term, the interest rate is 4%/year

7

1.2.10 The corporate tax rate:

Pursuant to Article 10, Consolidated Document (No 14/VBHN-VPQH) of theLaw on Corporate Income Tax: the corporate income tax rate in 2023 is 20%

1.2.11 Expected risks:

Although there are many opportunities for development, the children's fashionindustry also faces challenges and difficulties from the competitive market and otherfactors The project's biggest risk variables are expected to be: discount rate (WACC),sales volume, and selling price per year

1.3 Summary of investment project:

Mothercare Company plans to implement a new investment project with thefollowing information:

- Project life cycle: 6 years The company estimates that the sales volume at theend of the first year will be 9,000 units Each year increases by 1,000 units.- Selling price at the end of the first year will be 280,000 VND/product, and the

sale price unit growth of 6% per year.- Operating costs (excluding depreciation) account for 30% of revenue.- The project requires an initial fixed asset investment of 6,000,000,000 VND It

will be depreciated straight-line for 6 years At the end of year 6, the asset issold (liquidated) with a after-tax value of 1,000,000,000 VND

- The initial net working capital requirement for the project (year 0) is800,000,000 VND, and NWC will be recovered at the end of the project’s life.- The corporate tax rate is 20%

- Initial costs for the project are mobilized from two sources of funding: 30%bank loan with an interest rate of 4% and 70% equity with a cost of 16%

CHAPTER 2: PROJECT INVESTMENT ANALYSIS

2.1 Weighted Average Cost of Capital (WACC):

Weighted average cost of capital (WACC) represents a company's cost ofcapital, with each category of capital (debt and equity) proportionately weighted.WACC is an important factor that acts as a discount rate to calculate the net presentvalue of a business Formula to calculate WACC:

WACC =(EV× ℜ)+(D

V× Rd ×(1−Tc))

E: Market value of the firm’s equityD: Market value of the firm’s debtV=E+D

Re: Cost of equityRd: Cost of debtTc: Corporate tax rate

The project has a 30% bank loan with an interest rate of 4% and 70% equitywith a cost of 16%, the tax rate is 20%

Table 1: The table shows the company's sales revenue

2.2.4 Annual net cash flow:

- Earnings Before Tax (EBT) = Sales Revenue – Variable Cost – Depreciation

- Earnings After Tax (EAT) = Earnings Before Tax (EBT) (1 – Tax rate)

- Operating Cash Flow (OCF) = Earnings After Tax (EAT) + Depreciation

The project requires an initial fixed asset investment of 6,000,000,000 VND.At the end of year 6, the asset is sold (liquidated) with an after-tax value of1,000,000,000 VND The initial net working capital requirement for the project (year0) is 800,000,000 VND, and NWC will be recovered at the end of the project’s life

The NPV of the project will be calculated as the sum of OCF, Initial Cost andNWC, the results are presented in the figure below:

Figure 1: The figure shows the project’s annual net cash flow

2.3 Project assessment:

In this section, I use two methods to evaluate the feasibility of the project:

Method 1: Net Present Value (NPV)

Net Present Value (NPV) is the present value of all future project cash flowsdiscounted to the present I will use the NPV formula in Excel to calculate the netpresent value of this project:

=NPV(discount rate, series of cash flow)

Result: NPV = 3,217,245,734 > 0 Accept this project

Method 2: Internal Rate of Return (IRR)

Internal Rate of Return (IRR) is the discount rate that will cause the NetPresent Value (NPV) of a project to be zero when applied to its cash flows IRRrepresents the rate of return that a project or investment has can earn every year I willuse the IRR formula in Excel to calculate the internal rate of return of this project:

=IRR(series of cash flow)

Result: IRR = 25% > WACC Accept this project

2.4 Analyze fluctuations in NPV using Data Table:2.4.1 Change in project discount rate:

In the study, the NPV is calculated by the formula:

Suppose that the discount rate (input variable) changes from 0% with a rate ofchange of 2% I use Data Table in Excel to show the change in NPV according todifferent values of the discount rate:

Step 1: List the input variables - discount rate

Step 2: Select the NPV reference cell (declare the NPV formula)

11

Step 3: Select the entire area of the Data Table including input variable (discountrate), output variable reference cell (NPV), NPV value cells.

Data What-If Analysis Data Table Column input cell (WACC reference cell)

Figure 2: The figure shows the fluctuations of NPV according to WACC

From the results we can easily see that when the discount rate increases from0% to 24%, the NPV of the project will decrease from 8,963,386,809 to168,544,767.When the discount rate is 26% or higher, the NPV of the project willhave a negative value and the project will not bring profit in the future The NPVgraph intersects the Ox axis at a point, the IRR, where NPV is 0 That shows theinverse relationship between NPV and discount rate

According to the discounted cash flow model, investors must demand largerreturns because as the discount rate rises, the value of future cash flows would decline.In other words, the present value of future cash flows will decrease with increasingdiscount rates Conversely, the present value of future cash flows will increase with alower discount rate

2.4.2 Change in project output at the end of year 1:

Suppose that the quantity at the end of year 1 is 7,000 units with a change of500 units I use a Data Table in Excel to show the change in NPV for different valuesof year 1's quantity With similar operations, where the input variable is quantity andthe output variable is NPV, the results are presented in the following table

Figure 3: The figure shows the fluctuations of NPV according to the quantity

The sales volume at the end of the first year is 7,000 units then the NPV will beequal 1,753,795,787 If it increases to 7,500 units/year, NPV will be equal2,119,658,273, and so on In conclusion, when the quantity increases, the NPV of theproject will increase, and vice versa That means NPV and quantity have a positiverelationship

2.4.3 Change in both project output and sale price at the end of year 1:

Assume that there is a simultaneous change in two input variables, the salesvolume and the selling price at the end of year 1 In which, the quantity at the end ofyear 1 is 7,000 units with a change of 500 units; The selling price in year 1 changes to200,000 VND with a 5% change In this case, the input variables are the quantity andselling price, the output variable is the NPV

- Step 1: List the input variables – the quantity and selling price

- Step 2: Select the NPV reference cell (declare the NPV formula)

- Step 3: Select the entire area of the Data Table including input variables, output variable reference cell (NPV), NPV value cells

Data What-If Analysis Data Table Row input cell (Price reference cell),Column input cell (WACC reference cell)

The following table displays the change in NPV for different values of quantity and selling price in year 1:

13

Figure 4: The figure shows the fluctuations of NPV according to the quantity and price

The above table shows that for each value of selling price and output, there willbe a different NPV level For example, with the selling price equal 200,000 VND andoutput equal 10,000 units, the NPV of the project is 1,370,043,965 Similar to othervalues, Data Table will allow investors to analyze fluctuations in NPV according torisk variables However, the limitation of Data Table is that it can only analyze amaximum of two changing input variables

2.5 The risk estimation of the investment project using Monte Carlo simulationmodel:

2.5.1 Model with random demand curve:

However, demand cannot be determined accurately for each year As decisionmakers, investors need to be more realistic and wish to establish a model where thequantity demanded each year is not a constant value, but changes according to randomvariables

If the annual sales volumes are not as expected, the project is risky when the

output is a uncertain, random variable that can take on the following values: 4000,

5000, 6000, 7000, 8000, 9000, 10000, 11000

2.5.2 The project's probability distribution:

The random variables – ouput are based on Uniform Probability

Distribution

In statistics, Uniform Distribution is a form of statistical probabilitydistribution in which random values in the range (min, max) have equal probability of

occurring

Figure 5: The figure shows the distribution of Demand function

2.5.3 Simulate demand values using an Excel spreadsheet: