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Risk Analysis - Answer

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Vrinda Tayade
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48 views7 pages

Risk Analysis - Answer

Notes

Uploaded by

Vrinda Tayade
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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FINANCIAL MANAGEMENT

RISK ANALYSIS
ANSWERS

Question 1

i. Expected NPV

ii. Possible deviation in the expected value

Page 1
iii. Standard deviation is a statistical measure of dispersion; it measures the
deviation from a central number i.e. the mean.
In the context of capital budgeting decisions especially where we take up two
or more projects giving somewhat similar mean cash flows, by calculating
standard deviation in such cases, we can measure in each case the extent of
variation. It can then be used to identify which of the projects is least
riskier in terms of variability of cash flows.
A project, which has a lower coefficient of variation will be preferred if
sizes are heterogeneous.

Page 2
Besides this, if we assume that probability distribution is approximately
normal we are able to calculate the probability of a capital budgeting project
generating a net present value less than or more than a specified amount.

Question 2

Calculation of Variance and Standard Deviation

Calculation of Coefficient of Variation

Project S is riskier as it has higher Coefficient of Variation.

Page 3
Question 3

1. Calculation of Net Cash Inflow per year:

Calculation of Net Present Value (NPV) of the Project:

Here NPV represent the most likely outcomes and not the actual
outcomes. The actual outcome can be lower or higher than the expected
outcome.

Page 4
2. Sensitivity Analysis considering 2.5 % Adverse Variance in each variable

Page 5
The above table shows that the by varying one variable at a time by
2.5% while keeping the others constant, the impact in percentage terms
on the NPV of the project. Thus it can be seen that the change in
selling price has the maximum effect on the NPV by 24.82 %.

Page 6
Question 4

The possible outcomes will be as follows:

Now suppose that CEO of XYZ Ltd. is bit confident about the estimates in the first
two years, but not sure about the third year’s high cash inflow. He is interested in
knowing what will happen to traditional NPV if 3rd year turn out the bad contrary
to his optimism.
The NPV in such case will be as follows:

Page 7

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