Seventy-Nine Cents a Pallet From No: Stress-Testing a Freezer Facility's Net Present Value Until the Decision Changes
Student Name
American College of Education
FIN5003: Financial Decision Making
Module 4 Assignment
Instructor Name
July 24, 2028
Why Stress a Thin Result
In Module 3, the invented freezer-warehouse operator's $68 million project cleared its 8.8 percent hurdle by roughly $3.2 million in present value, and the paper recommended going ahead on the condition that the customer's renewal be protected. A value that small relative to the investment could disappear with modest changes in the assumptions. Before the company commits, it needs to know which assumptions matter most and how far each can move before the answer changes. Brealey et al. (2023) describe sensitivity analysis, scenario analysis and break-even analysis as the standard tools for exactly this purpose. The point of stress-testing is not to find the right number but to find the numbers that deserve the most attention.
One Input at a Time
Each input was moved by a plausible amount while the others were held at base values. A 10 percent construction cost overrun, which is common for projects of this kind, reduces net present value from $3.2 million to about negative $3.6 million. Filling only half the expected uncontracted space, 2,000 positions rather than 4,000, reduces it to about negative $3.7 million. Price escalation of 1.5 percent a year instead of 2.5 percent reduces it to about negative $3.9 million. A contract storage price 5 percent lower, about $20.90 instead of $22.00, reduces it to about negative $1.3 million. A discount rate of 9.3 percent, the top of Module 2's range, reduces it to about negative $0.2 million. By contrast, 30 percent higher energy costs reduce it only to about $0.4 million, and a terminal value multiple of 7 rather than 8 reduces it to about $1.3 million.
The ranking is instructive. Energy, which dominated the refrigeration choice in Module 1, matters relatively little to the project as a whole, because it is a small share of costs and the carbon dioxide system already reduced it. Construction cost, uncontracted occupancy and escalation matter most, and each is partly within Fenwick's control.
Break-Even Values
Sensitivities answer the question of what happens if an input changes by a given amount; break-even values answer the more useful question of how far each input can move before net present value reaches zero. The contract storage price can fall to about $21.21 per pallet per month, 79 cents or about 3.6 percent below the offered $22.00. Construction cost can rise to about $71.2 million, an overrun of about $3.2 million or 4.7 percent. The terminal value multiple can fall to about 6.3 times operating cash earnings. Energy costs can rise about 34 percent, to about $1.15 million in the first year. The discount rate can rise to about 9.3 percent, the internal rate of return.
Two of these margins are uncomfortably small. A 4.7 percent construction overrun is well within normal experience, and a 3.6 percent difference in contract price is the kind of concession that could be traded away in a final negotiating session without anyone noticing that it made the project worthless.
Scenarios
Inputs do not move one at a time in reality; a weak economy tends to lower occupancy, escalation and terminal values together. Three scenarios were built. The base case is Module 3's unchanged, worth about $3.2 million in present value. The downside combines a 5 percent construction overrun, half the expected uncontracted occupancy, 2 percent escalation and a terminal multiple of 7; its net present value is about negative $11.9 million. The upside combines a 2 percent construction saving, 50 percent more uncontracted occupancy, 3 percent escalation and a terminal multiple of 9; its net present value is about $18.1 million. Weighting the downside and upside at 25 percent each and the base at 50 percent gives an expected value of about $3.2 million, essentially the base case, but with a wide spread.
The spread matters for a company of Fenwick's size. A loss of $12 million in present value would be a serious blow, roughly a fifth of the company's equity. Froot et al. (1993) argued that firms should care about such outcomes when losses constrain future investment, and Fenwick's ability to fund its next expansion would be impaired in the downside case.
Why Forecasts Lean Optimistic
The base case itself deserves skepticism. Kahneman and Lovallo (1993) argued that managers tend to make bold forecasts because they view each project as unique, taking an inside view focused on its specific plans rather than an outside view based on the outcomes of similar projects. The outside view would ask how often refrigerated warehouse projects of this size came in on budget and how quickly their uncontracted space actually filled. Flyvbjerg (2014), reviewing large projects, found that cost overruns and benefit shortfalls are the norm rather than the exception, driven partly by optimism. Fenwick's own record is relevant: its last expansion ran 7 percent over budget and took 30 months, not 18, to reach target occupancy. Applying that history to this project alone would push net present value below zero.
A Simulation Using the Company's Own History
To combine the uncertainties more fully, the team ran 2,000 simulated versions of the project, drawing each input from a range rather than a single value. Construction cost was drawn from 3 percent under budget to 15 percent over, most likely 3 percent over, reflecting Fenwick's own record. Uncontracted occupancy ranged from 1,000 to 5,000 positions, most likely 3,500. Escalation ranged from 1.5 to 3.5 percent, the terminal multiple from 6 to 10 and the contract price from $21.50 to $22.50, reflecting the final negotiation. The average net present value across the simulations was about negative $3.0 million, and about 72 percent of the simulated outcomes were negative. The result differs from the base case because the ranges are lopsided in the way experience suggests: overruns are more likely than savings, and occupancy is more likely to fall short of plan than to exceed it.
The team then reran the simulation with the protections proposed below: construction cost capped at 1.5 percent above budget through a guaranteed maximum price, the contract price fixed at $22.00 and a signed tenant guaranteeing at least 2,000 uncontracted positions. The average net present value rose to about $0.7 million, and the share of negative outcomes fell to about 45 percent. The protections turn a likely loss into a roughly even proposition, which is better but not yet comfortable.
What the Stress Test Means for the Decision
The stress test does not reverse Module 3's recommendation, but it sharpens its conditions. Fenwick should proceed only if it can protect the three inputs that matter most. On price, it should treat $22.00 as a floor in the final negotiation, and trade length of commitment, not price, for any concession. On construction cost, it should obtain a guaranteed maximum price contract with the builder, transferring overrun risk above a set amount, even at a premium of 1 or 2 percent. On uncontracted occupancy, it should sign at least one additional tenant for 2,000 positions before breaking ground. If any of the three cannot be secured, the decision should be revisited. Even with all three, the simulation suggests the project is close to a coin flip, which is why the renewal protection from Module 3, and possibly a longer initial term, remain essential rather than optional.
References
Brealey, R. A., Myers, S. C., & Allen, F. (2023). Principles of corporate finance (14th ed.). McGraw Hill.
Flyvbjerg, B. (2014). What you should know about megaprojects and why: An overview. Project Management Journal, 45(2), 6-19. https://doi.org/10.1002/pmj.21409
Froot, K. A., Scharfstein, D. S., & Stein, J. C. (1993). Risk management: Coordinating corporate investment and financing policies. The Journal of Finance, 48(5), 1629-1658. https://doi.org/10.1111/j.1540-6261.1993.tb05123.x
Kahneman, D., & Lovallo, D. (1993). Timid choices and bold forecasts: A cognitive perspective on risk taking. Management Science, 39(1), 17-31. https://doi.org/10.1287/mnsc.39.1.17
How this FIN 5003 Module 4 example is structured
FIN 5003 Module 4 often stresses the model, moving inputs until the decision changes; your classroom's instructions decide whether sensitivity, scenario or simulation methods are required. This example begins with one-at-a-time sensitivities and converts each into a break-even value, the most useful form for managers. It then combines inputs into scenarios, discusses why forecasts tend to be optimistic and ends with actions that address the inputs to which the decision is most sensitive.
FIN5003 Module 4 questions, answered
What does FIN5003 Module 4 usually ask for?
FIN5003 Module 4 often asks students to test how sensitive a capital budgeting decision is to its assumptions, using sensitivity analysis, break-even values, scenarios or simulation. Your classroom's instructions decide the methods required.
What is a break-even value in capital budgeting?
It is the value of an input, such as price or cost, at which net present value equals zero, holding the other inputs constant. It shows how far an assumption can move before the decision changes.
Why combine inputs into scenarios?
In reality, inputs tend to move together, for example in a recession. Scenarios combine consistent changes in several inputs to show the range of outcomes, which one-at-a-time sensitivities understate.
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