How to Build Internally Consistent Bull, Base, and Bear Scenarios
Build scenarios linking sales volumes, prices, costs, and fixed expenses instead of changing only growth rates. A worked example separates probability-weighted outcomes from the risk of a funding shortfall.
Build all three scenarios from the same business model using internally consistent assumptions for volume, price, and costs. The purpose is to identify the events leading to each path and whether cash holds up in the bear case, rather than focus only on the average outcome.
Choose business variables before setting earnings outcomes
Changing only the result—for example, profit up 30% in the bull case and down 30% in the bear case—makes it hard to know which conditions to monitor. Choose variables that can be linked to disclosures, such as order volumes, customer delivery schedules, selling prices, and raw-material costs. Changing too many variables makes causes hard to trace, so start with those that matter most. The base case is the set of conditions best supported by available information, not the arithmetic midpoint between bull and bear. Keep formulas linking revenue and profit automatically whenever an assumption changes.
Check combinations of favorable and unfavorable conditions
Combining weak demand with the highest selling price and lowest costs can produce an outcome unlikely to occur in practice. Raw-material prices may fall during an economic slowdown, but selling prices may fall faster. Lower utilization can reduce outsourcing costs while increasing the fixed-cost burden per unit. Explain these relationships briefly and ensure each scenario is logically consistent. Company risk factors and financial-instrument risk disclosures help identify omitted variables; three scenarios do not cover every possibility.
Assess average earnings and survival separately
Even positive probability-weighted expected earnings are insufficient if the company cannot meet debt maturities in the bear case. Prepare a separate funding schedule incorporating cash balances, minimum working capital, and committed repayments. State whether probabilities reflect observable frequencies or the analyst’s judgment, and avoid asserting precise numbers when evidence is weak. Decide in advance which order volumes or prices in the next earnings release would trigger a scenario change. This helps prevent moving the goalposts by selecting only favorable assumptions after each result.
Worked example
Hypothetical example: Monetary amounts are in units of KRW 100 million, and quantities are simple units. The base case uses 100 units × a price of 1, variable cost of 0.6 per unit, and fixed costs of 30, producing profit of 10. The bull case uses 110 units × 1.05, less variable costs of 66 and fixed costs of 32, producing profit of 17.5. The bear case uses 80 units × 0.95, less variable costs of 48 and fixed costs of 30, producing a loss of 2. If the analyst assigns assumed probabilities of 25%, 50%, and 25% to the bull, base, and bear cases respectively, expected profit is 8.875 in these units. The probabilities are not validated forecasts; taxes and debt repayments are separate.
What to check
- Check whether the price, volume, and cost combinations are consistent in each scenario.
- State the basis for probabilities and identify subjective assumptions.
- Check cash and debt repayments at maturity separately in the bear case.
- Record which new information would trigger a scenario change.
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.