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Risk Analysis Techniques in Capital Budgeting

This document discusses various techniques for analyzing risk in capital budgeting. It describes statistical techniques like probability, variance, and coefficient of variation. Conventional techniques discussed are payback period, risk-adjusted discount rate, and certainty equivalent. Additional risk analysis techniques covered are sensitivity analysis, break-even analysis, scenario analysis, simulation analysis, and decision tree analysis. The presentation provides overviews and definitions of each technique for evaluating investment risk and uncertainty in capital budgeting decisions.

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Tapas Kumar
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126 views11 pages

Risk Analysis Techniques in Capital Budgeting

This document discusses various techniques for analyzing risk in capital budgeting. It describes statistical techniques like probability, variance, and coefficient of variation. Conventional techniques discussed are payback period, risk-adjusted discount rate, and certainty equivalent. Additional risk analysis techniques covered are sensitivity analysis, break-even analysis, scenario analysis, simulation analysis, and decision tree analysis. The presentation provides overviews and definitions of each technique for evaluating investment risk and uncertainty in capital budgeting decisions.

Uploaded by

Tapas Kumar
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd

RISK ANALYSIS IN CAPITAL BUDGETING

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

5/16/12

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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