# RISK ANALYSIS

RISK ANALYSIS OF A PROJECT 
Sources, measures and perspectives on risk  Sensitivity analysis  Scenario analysis  Break-even analysis  Hillier model  Simulation analysis  Decision tree analysis  How financial institutions analyse risk

4S  SENSITIVITY ANALYSIS  SCENARIO ANALYSIS  SIMULATION ANALYSIS  STRATEGIC ANALYSIS  SOCIAL COSTS AND BENEFIT ANALYSIS (SCBA) .

SOURCES OF RISK  Project-specific risk  Competitive risk  Industry-specific risk  Market risk  International risk .

MEASURES OF RISK  Range  Standard deviation  Variance  Coefficient of variation  Semi-variance  Semi-standard deviation .

Standard deviation THE PRINCIPAL MEASURE .

SUBJECTIVE VS OBJECTIVE PROBABILITIES .

PERSPECTIVES ON RISK  Stand-alone risk  Firm risk  Systematic risk  Focus on stand-alone risk .

000 1. 5. 8.000 Years 1-10 .000 4. 9. 2. 7.000 12. 4. 10.000 2. 3.000 4. Investment Sales Variable costs Fixed costs Depreciation Pre-tax profit Taxes Profit after taxes Cash flow from operation Net cash flow (20. In 000) Year 0 1. 6.000 3.000) (20.000) 18.SENSITIVITY ANALYSIS (r=12%) (Rs.000 1.000 2.

SENSITIVITY ANALYSIS  NPV positive for the expected values of the      underlying variables Which can vary widely Effect on NPV Do sensitivity analysis to variations in the value of key variables Vary one variable at a time Define the optimistic and pessimistic estimates for the underlying variables .

8 1.47 2. IN MILLION range NPV Key variable pessimistic expected optimistic pessimistic expected optimistic INVESTMENT 24 20 18 -0.40 VARIABLE COSTS AS A PERCENT OF SALES FIXED COSTS 70 66.17 2.0 0.60 3.66 65 0.34 2.33 .RS.73 1.3 1.22 SALES 15 18 21 -1.60 6.65 2.60 4.60 3.

EVALUATION OF SENSITIVITY ANALYSIS  Vulnerability analysis  Critical analysis  Intuitive articulation  Likelihood of change  Departs from reality  Subjective analysis .

SCENARIO ANALYSIS  Underlying variables are interrelated  Representation of scenarios reflecting consistent combination of variables .

uncertainty  Estimating the values of each of the variables  Complete investment analysis  Calculating NPV in each scenario .PROCEDURE  Factor selection.

SCENARIOS  Moderate appeal to customers across the board  Strong appeal to a large segment of the market  Appeal to a small segment of the market .

2 Scenario 2 200 15 40 600 480 50 20 50 25 25 45 10 years 0 25. In million) Scenario 1 Initial investment Unit selling price (in rupees) Demand (in units) Revenues Variable costs Fixed costs Depreciation Pre-tax profit Tax @ 50% Profit after tax Annual cash flow Project life Salvage value Net present value 200 25 20 500 240 50 20 190 95 95 115 10 years 0 377.(Rs.4 .9 Scenario 3 200 40 10 400 120 50 20 210 105 105 125 10 years 0 427.

OBJECTIVE  Best and worst case analysis  Assessing the most favourable or the most adverse configuration of key variables  Internal consistency of such configurations not given due importance .

EVALUATION OF SCENARIO ANALYSIS  Improvement over sensitivity analysis  Integration of number of variables  Few well-delineated scenarios  Information asymmetry from continuum to discrete states  Expanding the concept of estimating the expected values .

BREAK-EVEN ANALYSIS  Quantum to be produced and sold at a minimum  Ensuring no lose money  Defining break-even point in accounting terms or financial terms  ACCOUNTING BREAK-EVEN ANALYSIS .

4. Investment Sales Variable costs Fixed costs Depreciation Pre-tax profit Taxes Profit after taxes Cash flow from operation Net cash flow (20.000) (20. 8.000 2. 10.000 1.000) 18. 2.000 4. 9.000 Years 1-10 . 7.000 12.000 1.000 4. In 000) Year 0 1. 3.000 2.(Rs.000 3. 5. 6.

RS. IN MILLION SALES VARIABLE COSTS FIXED COSTS DEPRECIATION PROFIT BEFORE TAX TAX PROFIT AFTER TAX 9 6 1 2 0 0 0 .

NPV .ACCOUNTING BREAK-EVEN ANALYSIS  Stock that gives you return of zero per cent  Getting back original investment  Not compensated for time value of money  Not compensated for that risk you bear  Not compensated for forgoing the opportunity cost of your capital  Go for financial break-even analysis.

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