RISK ANALYSIS IN CAPITAL BUDGETING

PRESENTED BY: Click to edit Master subtitle style MADHAWI RAJAN (311SM1019)

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RISK
The risk associated with an investment may be

defined as the variability that is likely to occur in the future returns from the investment.
The inability of the decision-maker to make perfect

forecasts.

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Techniques
Statistical Techniques for Risk Analysis Conventional Techniques of Risk Analysis

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Statistical Techniques for Risk Analysis

Probability :

As a measure of someones opinion about the likelihood that an event will occur.
Variance or Standard Deviation :

Variance measures the deviation about expected cash flow of each of the possible cash flows.
Coefficient of Variation :

The coefficient of variation is a useful measure of risk when we are comparing the projects
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CONVENTIONAL TECHNIQUES OF RISK ANALYSIS Payback:

An attempt to allow for risk in capital budgeting decision
Risk-adjusted discount rate:

Allow for both time preference and risk preference and will be a sum of the risk-free rate and the riskpremium rate reflecting the investors attitude towards risk.
Certainty equivalent:

Reduce the forecasts of cash flows to some 5/16/12 conservative levels

Sensitivity Analysis
Also known as a "what if analysis Uncertainty of the future Entrepreneur wants to know about the feasibility of

a project in variable quantities

Calculated in terms of NPV, or net present value.

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Break Even Analysis

Allows a company to determine the minimum

production and sales amounts for a project to avoid losing money.

Lowest possible quantity at which no loss occurs. Break-even point can be delineated both in financial

or accounting terms.
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Scenario Analysis
Focus is on the deviation of a number of

interconnected variables.
Different from sensitivity analysis. Concentrates on the change in one particular

variable at a specific point of time.

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Simulation Analysis
Utilized for formulating the probability analysis for

a criterion of merit with the help of random blending of variable values.

Computes the probability distribution of NPV.

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Decision Tree Analysis

Principal steps are the definition of the decision tree

and the assessment of the alternatives

Steps : 1. Define investment 2. Identify decision alternatives 3. Draw a decision tree

decision points chance events 4. Analyse data

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THANK YOU
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