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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