Risk Analysis

Suppose you have a choice between two projects, both of which require the same initial investment, have identical net present values, and require the same yearly cash inflows to break even. If the cash inflow of the first investment has a probability of occurrence of 95% and that of the second investment is 70%, then risk analysis would indicate that the first investment is better.

Risk analysis refers to the chance that the selection of this project will prove to be unacceptable. In capital budgeting, risk analysis is almost entirely based upon how well we can predict cash inflows since the initial investment is usually known with some degree of certainty. The inflows, of course, are based upon sales projections, taxes, cost of raw materials, labor rates, and general economic conditions.

Sensitivity analysis is a simple way of assessing risk. A common approach is to estimate NPV based upon an optimistic (best case) approach, most likely (expected) approach,

Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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