RISK ANALYSIS 3.

Incorporating Risks Into Valuation - may

involve adjusting the expected future cash
The goal of risk analysis in valuation is to identify
flows of the company to account for the
potential risks that could negatively impact the
potential impact of each risk, as well as
future cash flows of a company and to estimate the
adjusting the discount rate to reflect the
impact of these risks on the value of the company.
increased risk. The discount rate is the rate of
RISK ANALYSIS STEPS return that investors require to compensate for
1. Identifying Risks – first step in risk analysis the time value of money and the risks
that could impact the future cash flows of a associated with the investment.
company; this may include economic risks, Industry Structure Analysis
industry-specific risks, regulatory risks, and
company risks.
 Economic Risks – refers to the possibility
that economic factors such as recession,
inflation, interest rates, exchange rates,
and government policies will negatively
impact a company’s financial performance.
 Regulatory Risks – refers to the risks that
changes in laws, regulations, or policies
that may negatively impact a company’s
financial performance. This type of risk can
arise from a variety of sources, including
changes in government policies, new
regulations, and legal challenges. Threat of New Entrants - If the barriers to entry
 Industry-Specific Risks – refers to the are low, new entrants may be able to enter the
risks that are unique to a particular industry market easily and compete with existing
and are not present in other industries. companies, reducing their profitability.
These risks can be a result of factors such
Threat of Substitute Products or Services - If
as regulatory environment, technology,
there are many substitute products or services
competition, and consumer behavior.
available, customers may choose to switch to a
 Company-Specific Risks - refers to the
different product or service, reducing the demand
risks that are unique to a particular
for the existing product or service and reducing its
company and are not present in other
profitability.
companies in the same industry. These
risks can be a result of factors such as Bargaining Power of Suppliers - If suppliers
management quality, operational have a lot of bargaining power, they may be able
efficiency, and financial performance. to charge higher prices for their products or
services, reducing the profitability of existing
2. Assessing the Likelihood - next step is to companies.
assess the likelihood of each risk occurring.
This may involve reviewing historical data and Bargaining Power of Buyers - If buyers have a
market trends, as well as consulting with lot of bargaining power, they may be able to
industry experts and management. The negotiate lower prices for the products or services
likelihood of each risk occurring can be they purchase, reducing the profitability of existing
expressed in terms of probabilities or companies.
frequencies. Rivalry Among Existing Competitors - If there is
 Estimating the Impact - next step is to intense competition among existing companies,
estimate the impact of each risk on the they may have to reduce their prices or invest in
future cash flows of the company. This marketing and advertising in order to remain
may involve estimating the magnitude and competitive, reducing their profitability.
duration of the impact, as well as the
likelihood of each risk occurring. The Retail Industry
impact of each risk can be expressed in  Threat of new entrants – low barriers to entry
terms of dollar amounts or percentage for new entrants (e.g., low capital
changes in the expected cash flows. requirements)
 Threat of substitute products or services –
The retail industry faces significant
competition from substitute products or
services (e.g., online retailers, discount stores)
 Bargaining power of suppliers – The
bargaining power of suppliers in the retail
industry is low, as there are many suppliers
available and the company can switch to
another supplier if necessary.
 Bargaining power of buyers – The
bargaining power of buyers in the retail
industry is high, as customers have many
options for purchasing products and services.
This increases the bargaining power of buyers,
who may be able to negotiate lower prices for
the products and services they purchase.