RISK ANALYSIS
- Study of risk/uncertainty factor of any investment proposal
Factors of uncertainty
1. process or product becoming obsolete
2. decline in demand
3. change in Govt policy in business
4. price fluctuation
5. foreign exchange restriction
6. inflationary tendencies
Techniques
I. Conservative: 1. Short Pay Back Period
2. Risk Adjusted Discount Rate
3. Conservative Forecasts of Certainty
Equivalent
Ii. Modern Methods:1. Sensitivity Analysis
2. Probability Analysis
3. Decision Tree Analysis
I. 1. Short Pay Back Period: Projects with short pay back period are normally preferred to those with longer pay back period. It would be effective when it combined with a cut off period. The cut off period denotes the risk tolerance level of the firm.
I. 2. Risk adjusted discount rate: Under this method, the cut off rate or minimum required rate of return is raised by adding what is greater.
I. 3. Conservative forecasts of certainty equivalent: It deals with the uncertainty in cash flow. Under this method, the estimated risks from cash flows are reduced by employing initiative corrective factors or certainty equivalent coefficient, which is calculated by the decision maker subjectively or objectively. Normally, this coefficient reflects the decision maker’s confidence in obtaining a particular cash flow in a particular period.
II.1. Sensitivity analysis:SENANA.DOC
II.2. probability analysis: The measure of some one’s opinion about the likelihood that an event (cash flow) will occur. The range of probability is 1 to 0. That is 100 % certain to 100% uncertain. The measure can be classified into 1. Optimistic 2. Pessimistic 3. Most likely based objective or subjective factors.
II. 3. Decision tree: In this analysis alternative course of action are charted into a form of branches left to right. The nodes represents either the chance event (denoted by a circle) and a decision point (denoted by a square). The process starts from the extreme right hand decisions and travel stage by stage along the branches that maximize interest. This process is known as Roll Back Method.
- Study of risk/uncertainty factor of any investment proposal
Factors of uncertainty
1. process or product becoming obsolete
2. decline in demand
3. change in Govt policy in business
4. price fluctuation
5. foreign exchange restriction
6. inflationary tendencies
Techniques
I. Conservative: 1. Short Pay Back Period
2. Risk Adjusted Discount Rate
3. Conservative Forecasts of Certainty
Equivalent
Ii. Modern Methods:1. Sensitivity Analysis
2. Probability Analysis
3. Decision Tree Analysis
I. 1. Short Pay Back Period: Projects with short pay back period are normally preferred to those with longer pay back period. It would be effective when it combined with a cut off period. The cut off period denotes the risk tolerance level of the firm.
I. 2. Risk adjusted discount rate: Under this method, the cut off rate or minimum required rate of return is raised by adding what is greater.
I. 3. Conservative forecasts of certainty equivalent: It deals with the uncertainty in cash flow. Under this method, the estimated risks from cash flows are reduced by employing initiative corrective factors or certainty equivalent coefficient, which is calculated by the decision maker subjectively or objectively. Normally, this coefficient reflects the decision maker’s confidence in obtaining a particular cash flow in a particular period.
II.1. Sensitivity analysis:SENANA.DOC
II.2. probability analysis: The measure of some one’s opinion about the likelihood that an event (cash flow) will occur. The range of probability is 1 to 0. That is 100 % certain to 100% uncertain. The measure can be classified into 1. Optimistic 2. Pessimistic 3. Most likely based objective or subjective factors.
II. 3. Decision tree: In this analysis alternative course of action are charted into a form of branches left to right. The nodes represents either the chance event (denoted by a circle) and a decision point (denoted by a square). The process starts from the extreme right hand decisions and travel stage by stage along the branches that maximize interest. This process is known as Roll Back Method.
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