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Risk Analysis in Capital
Budgeting
By: Vikram.G.B
Lecturer, P.G dept. of Commerce
V.D.C, Bangalore-55
Risk & uncertainty:-
• Uncertainty is a situation where a decision can
lead to more than one possible outcome.
• Risk exists because of the inability of the
decision maker to make perfect forecast.
• Traditional difference between Risk &
Uncertainty is
▫ uncertainty can't be quantified whilst risk can.
• Risk is concerned with the use of quantification
of the likelihood of future outcomes.
• Uncertainty is to cover all future outcomes
which cannot be predicted with accuracy.
Why Risk Arises in Investment Evaluation?
• Because unable to anticipate occurrence of the
possible future events with certainty and
consequently.
• Unable to make correct prediction about the
cash flow sequence.
Categories of Risk:-
Risk
Unsystematic
Risk
Business
Risk
Internal
External
Financial
Risk
Systematic
Risk
Market Risk Interest Risk Inflation
Risk
Systematic Risk:-
• It relates to economic trend whichs affect the
whole market.
• It is a that portion of variation in return caused
by the factors that affect the prices of all
securities and it can’t be avoided.
• The effect in a systematic return causes the
prices of all individual shares/bonds to move in
the same direction.
Reasons for occurring of Systematic Risk
• Market Risk: Variations in price sparked off due to
real social, political and economic events.
• Interest Rate Risk: Uncertainty of future market
values and the size of future incomes, caused by
fluctuations in the general level of interest.
• Inflation Risk: It is referred to uncertainties of
purchasing power due to inflation.
Unsystematic Risk:-
• It is that portion of risk which is caused due to
factors unique or related to a firm or industry.
• This type of risk can be eliminated by
diversification of portfolio.
Reasons for occurring of unsystematic Risk
• External Business Risk: It arises due to change
in operating conditions caused by conditions
thrust upon the firm which beyond its control.
• Internal Business Risk: It is associated with the
efficiency with which a firm conducts its
operations within the broader environment
imposed upon it.
• Financial Risk: It is associated with the capital
structure of a firm.
 The extent of financial risk depends on the leverage
of the firm’s capital structure.
Investors’ Attitude to Risk:-
• Common investors will have 3 possible attitudes to
undertake risky course of action
▫ An aversion to risk.
▫ A desire to take risk.
▫ An indifference to risk.

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Risk analysis in capital budgeting

  • 1. Risk Analysis in Capital Budgeting By: Vikram.G.B Lecturer, P.G dept. of Commerce V.D.C, Bangalore-55
  • 2. Risk & uncertainty:- • Uncertainty is a situation where a decision can lead to more than one possible outcome. • Risk exists because of the inability of the decision maker to make perfect forecast. • Traditional difference between Risk & Uncertainty is ▫ uncertainty can't be quantified whilst risk can.
  • 3. • Risk is concerned with the use of quantification of the likelihood of future outcomes. • Uncertainty is to cover all future outcomes which cannot be predicted with accuracy.
  • 4. Why Risk Arises in Investment Evaluation? • Because unable to anticipate occurrence of the possible future events with certainty and consequently. • Unable to make correct prediction about the cash flow sequence.
  • 6. Systematic Risk:- • It relates to economic trend whichs affect the whole market. • It is a that portion of variation in return caused by the factors that affect the prices of all securities and it can’t be avoided. • The effect in a systematic return causes the prices of all individual shares/bonds to move in the same direction.
  • 7. Reasons for occurring of Systematic Risk • Market Risk: Variations in price sparked off due to real social, political and economic events. • Interest Rate Risk: Uncertainty of future market values and the size of future incomes, caused by fluctuations in the general level of interest. • Inflation Risk: It is referred to uncertainties of purchasing power due to inflation.
  • 8. Unsystematic Risk:- • It is that portion of risk which is caused due to factors unique or related to a firm or industry. • This type of risk can be eliminated by diversification of portfolio.
  • 9. Reasons for occurring of unsystematic Risk • External Business Risk: It arises due to change in operating conditions caused by conditions thrust upon the firm which beyond its control. • Internal Business Risk: It is associated with the efficiency with which a firm conducts its operations within the broader environment imposed upon it.
  • 10. • Financial Risk: It is associated with the capital structure of a firm.  The extent of financial risk depends on the leverage of the firm’s capital structure.
  • 11. Investors’ Attitude to Risk:- • Common investors will have 3 possible attitudes to undertake risky course of action ▫ An aversion to risk. ▫ A desire to take risk. ▫ An indifference to risk.