This document discusses key concepts related to capital budgeting and risk analysis. It begins with definitions of capital budgeting as the process of identifying, evaluating, planning, and financing capital investment projects. It describes the main features of capital budgeting projects as having large anticipated benefits, high risk, and a long time period between initial outlay and return.
The document then covers various capital budgeting techniques for evaluating projects, including payback period, net present value (NPV), and internal rate of return (IRR). It provides examples of calculating each measure and the criteria for accepting projects. Finally, it discusses risk in capital budgeting, defining it as uncertainty in cash flow forecasts, and methods for measuring risk, such as
,
capital budgeting
,
concept of capital budgeting
,
the capital budgeting process
,
significance of capital budgeting
,
classification of investment project proposals
,
techniques of capital budgeting
,
types of project
Capital Budgeting is about how one should evaluate the financing options based on the superior financial performance through mathematical techniques. These techniques have been discussed in the presentation in detail.
,
capital budgeting
,
concept of capital budgeting
,
the capital budgeting process
,
significance of capital budgeting
,
classification of investment project proposals
,
techniques of capital budgeting
,
types of project
Capital Budgeting is about how one should evaluate the financing options based on the superior financial performance through mathematical techniques. These techniques have been discussed in the presentation in detail.
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. It may be positive, zero or negative.
NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.
Also known as sophisticated technique for capital budgeting exercise.
It accounts for time value of money by using discounted cash flows in the calculation.
A simple and comprehensive presentation on Profit maximization v/s Wealth Maximization.
By Arvinder Pal Kaur
Faculty of Management
Northwest Group of Institutions
Dhudhike, MOGA
This PPT contains the full detail of topic leverage in financial management
it covers following topics :-
Meaning of Leverage
Types of Leverage
Operating Leverage
Financial Leverage
Difference between Operating & Financial Leverage
Combined Leverage
Illustrations
Exercise
This ppt is all about the long term finance for the business. From which sources a business firm used to get their long term finance to run the business. So i hope it will help you to give your presentation . Thanks for the download. And if you find any mistake, please feel free to comment and inform.
or send me a mail in tatinpisa@outlook.com
Venture capitalists influenced significantly the information and industrial technology revolution of the twentieth century. If we want to make up for lost time in Africa, it would be perhaps time to solicit the creation and access of funds from Capital Risks.
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. It may be positive, zero or negative.
NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.
Also known as sophisticated technique for capital budgeting exercise.
It accounts for time value of money by using discounted cash flows in the calculation.
A simple and comprehensive presentation on Profit maximization v/s Wealth Maximization.
By Arvinder Pal Kaur
Faculty of Management
Northwest Group of Institutions
Dhudhike, MOGA
This PPT contains the full detail of topic leverage in financial management
it covers following topics :-
Meaning of Leverage
Types of Leverage
Operating Leverage
Financial Leverage
Difference between Operating & Financial Leverage
Combined Leverage
Illustrations
Exercise
This ppt is all about the long term finance for the business. From which sources a business firm used to get their long term finance to run the business. So i hope it will help you to give your presentation . Thanks for the download. And if you find any mistake, please feel free to comment and inform.
or send me a mail in tatinpisa@outlook.com
Venture capitalists influenced significantly the information and industrial technology revolution of the twentieth century. If we want to make up for lost time in Africa, it would be perhaps time to solicit the creation and access of funds from Capital Risks.
Payback period (PP) is the number of years it takes for a company to recover its original investment in a project, when net cash flow equals zero. In the calculation of the payback period, the cash flows of the project must first be estimated. The payback period is then a simple calculation.
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A Memorandum of Association (MOA) is a legal document that outlines the fundamental principles and objectives upon which a company operates. It serves as the company's charter or constitution and defines the scope of its activities. Here's a detailed note on the MOA:
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Legal Requirement: The MOA is a legal requirement for the formation of a company. It must be filed with the Registrar of Companies during the incorporation process.
Constitutional Document: It serves as the company's constitutional document, defining its scope, powers, and limitations.
Protection of Members: It protects the interests of the company's members by clearly defining the objectives and limiting their liability.
External Communication: It provides clarity to external parties, such as investors, creditors, and regulatory authorities, regarding the company's objectives and powers.
https://seribangash.com/difference-public-and-private-company-law/
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Amendment of MOA:
While the MOA lays down the company's fundamental principles, it is not entirely immutable. It can be amended, but only under specific circumstances and in compliance with legal procedures. Amendments typically require shareholder
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4. The process of identifying, evaluating, planning,
and financing capital investment projects of an
organization.
Capital budgeting is defined “as the firm’s
formal process for the acquisition and
investment of capital. It involves firm’s decisions
to invest its current funds for addition,
disposition, modification and replacement of
fixed assets”.
“Capital budgeting is long term planning for
making and financing proposed capital outlays”-
CharlesT. Horngreen.
5. Capital budgeting involves capital investment
projects which require large sum of outlay and
involve a long period of time – longer than the usual
cut-off of one year or normal operating cycle.
“Capital budgeting consists in planning
development of available capital for the purpose of
maximizing the long term profitability of the
concern” – Lynch
The main features of capital budgeting are
Potentially large anticipated benefits
A relatively high degree of risk
Relatively long time period between the initial
outlay and the anticipated return.
- OsterYoung
6. The success and failure of business mainly depends on
how the available resources are being utilized.
Main tool of financial management
All types of capital budgeting decisions are exposed to
risk and uncertainty.
They are irreversible in nature.
Capital rationing gives sufficient scope for the
financial manager to evaluate different proposals and
only viable project must be taken up for investments.
Capital budgeting offers effective control on cost of
capital expenditure projects.
It helps the management to avoid over investment
and under investments.
7. Capital investment decisions usually require
relatively large commitments of resources.
Most capital investment decisions involve
long-term commitments.
Capital investment decisions are more
difficult to reverse than short-term decisions.
8. Identification of potential projects
Process of preparing the master budget plan for a
certain period.
Generating the proposals for investment.
Proposals serve as the potential projects that will
be evaluated by top management for inclusion in
the over-all plan for the coming period.
9. Estimation of costs and benefits
Project proposal must meet some minimum
criteria set by the firm.
Estimates of expected costs that the firm would
incur for the project as well as the revenues or
cost savings that may be derived from the project.
10. Evaluation
Proposals are evaluated in the light of the
organizational goals and policies.
Various evaluation methods or analytical
techniques are used to ensure that only the most
desirable projects are accepted.
11. Development of the capital expenditure
budget
Consist all capital investment project proposals
that have been approved for the budget period.
The budget may be a simple listing of the capital
expenditure projects and the amounts of required
investment for each, or it may provide additional
descriptive data about the projects.
12. Re-evaluation
Must be reviewed periodically to determine if the
project meets the original expectations.
13. Replacement
When an existing capital investment wears out,
becomes obsolete, or suffers an irreparable
damage, such item should be quickly replaced in
kind so as not to unduly interrupt operations.
14. Improvement
May consider improvement of a certain product or
process, which may necessitate the acquisition of
capital investment projects.
15. Expansion
Involves enlargement of facilities, setting up an
additional business segment and invasion of new
markets.
16. ProjectTypes and Risk
Capital projects have increasing risk according to
whether they are replacements, expansion or new
ventures.
17. Stand-Alone and Mutually Exclusive Projects
Stand-alone project has no competing
alternatives
Mutually exclusive projects involve selecting one
project from among two or more alternatives
18. The Cost of Capital
The average rate a firm pays investors for use of
its long term money
20. Availability of funds
Structure of capital
Taxation policy
Government policy
Lending policies of
financial institutions
Immediate need of
the project
Earnings
Capital return
Economic value of
the project
Working capital
Accounting practice
Trend of earning
22. NET PRESENTVALUE RULE
NPV = PV-C0
The difference between the PresentValue of the
investment (future net cash flows, i.e., benefits and its
initial cost).
Ideas:
An investment is worth undertaking if it creates value
for its owners
An investment creates value if it worth more than the
costs within the time value of many framework.
23. If NPV >= 0, accept the project
If NPV <= 0, reject the project
25. PV = FV (1+i)-n
or
PV= FV x [1/(1+i)n]
or
PV= FV / (1+i)n
26. Let's assume we are to receive $100 at the end
of two years. How do we calculate the present
value of the amount, assuming the interest rate
is 8% per year compounded annually?
PV= FV / (1+i)n
28. Suppose you are depositing an amount today in
an account that earns 5% interest, compounded
annually. If your goal is to have Php. 5,000 in the
account at the end of six years, how much must
you deposit in the account today?
PV= FV / (1+i)n
32. “Payout method”
Involves computation of the payback period.
PAYBACK PERIOD
▪ Length of time required by the project to return the
initial cost of time.
33. According to this method, the project that
promises a quick recovery of initial
investment is considered desirable.
Example:
If a company wants to recoup the cost of a
machine within 5 years of purchase, the
maximum desired payback period of the
company would be 5 years.
34.
35. ADVANTAGES
1. Payback is simple to compute and easy to
understand.
2. Payback gives information about liquidity of
the project.
3. Payback period reduces risk of loss.
36. DISADVANTAGES
1. Payback does not consider the time value of
money.
2. It gives more emphasis on liquidity rather
than profitability of the project.
3. It does not consider salvage value of the
project.
4. It ignores the cash flows that may occur after
the payback period.
37.
38. Due to increased demand, the management of Rani
Beverage Company is considering to purchase a new
equipment to increase the production and revenues.
The useful life of the equipment is 10 years and the
company’s maximum desired payback period is 4
years. The inflow and outflow of cash associated with
the new equipment is given below:
39. The initial cost of equipment $37,500
Annual cash inflow:
Sales $75,000
Annual cash outflow:
Cost of ingredients $45,000
Salaries expenses $13,500
Maintenance expenses $1,500
Non cash expenses:
Depreciation $5,000
Required: Should Rani BeverageCompany
purchase the new equipment? Use payback
method for your answer.
40. Computation of net annual cash inflow:
$75,000 – ($45,000 + $13,500 + $1,500)
= $15,000
= $37,500/$15,000
=2.5 years
41. The management of Health Supplement Inc.
wants to reduce its labor cost by installing a new
machine.Two types of machines are available in
the market – machine X and machineY. Machine
X would cost $18,000 where as machineY would
cost $15,000. Both the machines can reduce
annual labor cost by $3,000.
Required: Which is the best machine to
purchase according to payback method?
42. Machine X MachineY
Cost of machine
(a)
$18,000 $15,000
Annual cost
saving (b)
$3,000 $3,000
Payback period
(a)/(b)
6 years 5 years
43. An investment of $200,000 is expected to
generate the following cash flows in six years:
Year Net cash flow
1 $30,000
2 $40,000
3 $60,000
4 $70,000
5 $55,000
6 $45,000
Required: Compute payback
period of the investment.
Should the investment be
made if management wants
to recover the initial
investment in 3 years or less?
44. (1). Because the cash inflow is uneven, the payback
period formula cannot be used to compute the
payback period.We can compute the payback period
by computing the cumulative net cash flow as follows:
Year Net cash flow
Cumulative
net cash
inflow
1 $30,000 $30,000
2 $40,000 $70,000
3 $60,000 $130,000
4 $70,000 $200,000
5 $55,000 $255,000
6 $45,000 $300,000
45. (2). As the payback period is longer than the
maximum desired payback period of the
management (3 years), the investment should
not be made.
46. - is the excess of the present value s of the
projects cash inflow over the amount of the
initial investment.
It provides an absolute measure of a projects
worth because it measure the total present value
of peso return. It also works equally well for
independent projects as it does for choosing
among mutually exclusive projects.
Estimate CFs (inflows & outflows).
Assess riskiness of CF’s.
Determine the appropriate cost of capital.
47. Accept the project if it’s NPV is equal or
greater than zero; otherwise, the project is
rejected.This means that the firm will earn a
return equal to or greater than its cost of
capital. If the NPV is negative, it means the
project does not meet the hurdle rate and it
should be rejected as the funds that would be
invested in it could earn a higher rate in some
other investments.
48. Project A has a net investment of P 120,000 and
annual net cash inflows of P 50,000 for five
years. Management wants to calculate Project
A’s net present value using a 16% discount.
49. Present value of cash inflows (P 50,000 x 3.274) P 163,700
Less: Net Investment 120,000
Net Present value P 43,700
Therefore, Project A should be accepted because it
could earn more than the desired minimum rate of
return as indicated by the positive net present value.
50. Agila Corp. plans to invest in a four-year project that will cost
P 750,000. Agila’s cost of capital is 8%. Additional
information on the project is as follows:
Cash flow from Present value
Year operations, net of taxes of P1 at 8%
1 P 200,000 0.926
2 220,000 0.857
3 240,000 0.794
4 260,000 0.735
Required:
Using the net present value method, determine whether the
project is accepted or not.
51. Present value of cash inflows at 8%:
Cash Inflows
Year Amount PV factor PV
1 P 200,000 0.926 P 185,200
2 220,000 0.857 188,540
3 240,000 0.794 190,560
4 260,000 0.735 191,100
Total P 755,400
Less: Present value of net investment 750,000
Excess or net present value P 5,400
52. Rate of return – it measure the speed that
money comes back to you after you invest.
It is written in % per year/per annum.
53. Also known as discounted rate of return and
time-adjusted rate of return.
It is the rate which equates the present
value of the future cash inflows with the cost of
the investment which produces them. It is also
the equivalent maximum rate of interest that
could be paid each year for the capital
employed over the life of an investment
without loss on the project.
54. Accept Project if IRR > Cost of Capital
Reject Project if IRR < Cost of Capital
55. An investment of P 50,000 will yield an average
annual cash return of P 7,500 a year for a period
of 10 years.What is the discounted rate of
return?
56. 1. PV Factor= Net Investment/AnnualCash
Returns
= 50,000/7,500
= 6.6667
2. Referring to the table for Present value of P1
received annually for 10 years, the column that
gives the nearest value to 6.6667 is the column
for 8 %.
57. 3.To get the exact rate of return, interpolate
between 8% and 10%.
8% - 6.710
=0.043
? - 6.667 =0.565
=0.522
10% - 6.145
Exact discounted rate of return = 8% +
(0.043/0.565 x 2%)
= 8% + 0.15%
= 8.15%
58. An investment amounting to P 100,000 is
expected to yield cash returns as follows:
Year Amount
1 P 40,000
2 50,000
3 60,000
Required: Compute the discounted rate of
return.
59. 1. Average cash return = P 150,000/3
= P 50,000
2. PV Factor = P 100,000/ 50,000
= 2
3. Referring to the table for PresentValue of P1
received annually period 3, the column that will
give the nearest value of 2 is the column for
22%.
60. For trial at 22%
Amount of Cash PV of Cash
Year Returns PV Factor Returns
1 P 40,000 0.820 P 32,800
2 50,000 0.672 33,600
3 60,000 0.551 33,060
P 99,460
61. ForTrial at 20 %
1 P 40,000 0.833 P 33,320
2 50,000 0.694 34,700
3 60,000 0.579 34,740
P 102,760
62. Discounted rate of return is 22%. If the exact discount
rate of return is required, interpolation may be
necessary. Computation will be:
22% - 99,460
=540
? - 100,000 =3,300
=2,760
20% - 102,760
Discounted rate of return = 22% - (540/3,300 x 2%)
= 22% - 0.30 %
= 21.70%
63.
64. Definition of Risk
The concept of Risk Averse
Measurement of Risk
65. Risk exists because of the inability of the decision-maker to make perfect
forecasts.
Risk is referred to a situation where the probability distribution of the
cash flow of an investment proposal is known.
65
FORECASTING RISK OR
ESTIMATION RISK Is the possibility that a bad decision will be made because
errors in the projected cash flows.
There is a danger that will conclude a project has a positive
NPV.
Risk should be considered in evaluating capital budgeting
projects in both informal and formal ways.
66. is a concept that addresses how people will
react to a situation with uncertain outcomes.
It attempts to measure the tolerance for risk
and uncertainty.
Risk aversion is the reluctance of a person to
accept a bargain with an uncertain payoff
rather than another bargain with a more
certain, but possibly lower, expected payoff.
66
67. Aversion is also a concept that addresses
how people will react to a situation with
uncertain outcomes. It attempts to measure
the tolerance for risk and uncertainty.
In the realm of finance and economics, Risk
Aversion is a concept that addresses how
people will react to a situation with uncertain
outcomes.
67
69. The basic form of “what-if” analysis.
One way to examine the risk of investment is to
analyse the impact of alternative combinations of
variables, called scenarios, on the project’s NPV (or
IRR).
The decision-maker can develop some plausible
scenarios for this purpose.
69
70. This is also known as a “what if analysis”.
This is calculated in terms of NPV, or net present
value.
Sensitivity analysis allows to see the impact of the
change in the behaviour of critical variables on the
project profitability.
Conservative forecasts include using short payback
or higher discount rate for discounting cash flows.
70
71. Except a very few companies most companies do not use
the statistical and other sophisticated techniques for
analysing risk in investment decisions.
Identification of all those variables, which have an
influence on the project’s NPV (or IRR).
Sensitivity analysis is a way of analysing change in the
project’s NPV (or IRR) for a given change in one of the
variables.
The decision maker, while performing sensitivity
analysis, computes the project’s NPV (or IRR)
71
72. It compels the decision-maker to identify the variables,
which affect the cash flow forecasts. This helps him in
understanding the investment project in totality.
It indicates the critical variables for which additional
information may be obtained. The decision-maker can
consider actions, which may help in strengthening the ‘weak
spots’ in the project.
It helps to expose inappropriate forecasts, and thus guides
the decision-maker to concentrate on relevant variables.
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73. It does not provide clear-cut results. The terms
‘optimistic’ and ‘pessimistic’ could mean different
things to different persons in an organisation. Thus,
the range of values suggested may be inconsistent.
It fails to focus on the interrelationship between
variables.
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74. Considers the interactions among variables and
probabilities of the change in variables. It computes the
probability distribution of NPV.
The simulation analysis involves the following steps:
First, you should identify variables that influence cash inflows and
outflows.
Second, specify the formula that relate variables.
Third, indicate the probability distribution for each variable.
Fourth, develop a computer programme that randomly selects
one value from the probability distribution of each variable and
uses these values to calculate the project’s NPV.
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75. Beta is a measure firms can use in order to
determine an investment's return sensitivity
in relation to overall market risk.
Beta describes the correlated volatility of an
asset in relation to the volatility of the
benchmark that said asset is being compared
to.
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76. Beta is also referred to as financial elasticity or
correlated relative volatility, and can be referred
to as a measure of the sensitivity of the asset's
returns to market returns, its non-diversifiable
risk, its systematic risk, or market risk.
Higher-beta investments tend to be more
volatile and therefore riskier, but provide the
potential for higher returns. Lower-beta
investments pose less risk, but generally offer
lower returns.
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Stand-Alone and Mutually Exclusive Projects
Stand-alone project has no competing alternatives
The project is judged on its own viability
Mutually exclusive projects involve selecting one project from among two or more alternatives
Usually different ways to do the same thing
Firms raise money from two sources: debt and equity
A project is a good investment if it is expected to generate a return that’s greater than the rate that must be paid to finance it
Net Investment
The net outflow of cash, a commitment of cash, or the sacrifice of an inflow of cash
Net Returns
Expected to be earned from the project being evaluated
Cost of Capital
The cost of using funds
Payback
How many years to recover initial cost/INVESTMENT
Net Present Value
Present value of inflows less outflows
Internal Rate of Return
Project’s return on investment
A positive NPV suggests that the project is expected to add value to the firm, and the project should improve shareholder’s wealth
The goal of financial management is to increase shareholder’s wealth, NPV is a goal measure of how well this project will meet this goal.
If you received $100 today and deposited it into a savings account, it would grow over time to be worth more than $100. This fact of financial life is a result of the time value of money, a concept which says it's more valuable to receive $100 now rather than a year from now. To put it another way, the present value of receiving $100 one year from now is less than $100.
To help analyze the alternatives, you would use a PV calculation to tell you the interest rate implicit in the second option.
PV calculations can also tell you such things as how much money to invest right now in return for specific cash amounts to be received in the future, or how to estimate the rate of return on your investments.
Payback
How many years to recover initial cost
Net Present Value
Present value of inflows less outflows
Internal Rate of Return
Project’s return on investment
Payback
How many years to recover initial cost
Net Present Value
Present value of inflows less outflows
Internal Rate of Return
Project’s return on investment
DOES NOT CONSIDER THE PRESENT VALUE OF CASH FLOWS.
AN INVESTMENT PROJECT IS ACCEPTED OR REJECTED ON THE BASIS OF PAYBACK PERIOD.
PERIOD OF TIME THAT A PROJECT REQUIRES TO RECOVER THE MONEY INVESTED IN IT.
EXPRESSED
If the payback period of a project computed by the above formula is shorter than or equal to the management’s maximum desired payback period, the project is accepted otherwise it is rejected.
The purchase of machine would be desirable if it promises a payback period of 5 years or less.
There is no need to compute or consider any interest rate. One has just to answer the question: “How soon will the investment cost be recovered?
Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price.
Quick payback period indicates a less risky project. caused by changing economic conditions and other unavoidable reasons.
All cash received during the payback period is assumed to be of equal value.
More emphasis is given on return OF investment rather than the return ON investment(what you will gain).
Salvage value- The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting to determine depreciation amounts and in the tax system to determine deductions. The value can be a best guess of the end value or can be determined by a regulatory body such as the IRS.
For example, If two projects, project A and project B require an initial investment of $5,000. Project A generates an annual cash inflow of $1,000 for 5 years whereas project B generates a cash inflow of $1,000 for 7 years. It is clear that the project B is more profitable than project A. But according to payback method, both the projects are equally desirable because both have a payback period of 5 years ($5,000/$1,000).
If the paybak method is used to evaluate these projects,
Project 1 seems to be more preferrable because its payback period is shorter. However, a closer look at the projects will show that after the payback period, project 2 would generate 135,000 cash inflow (375-240) which is greater than project 1’s 75,000. moreover, the timing of cash flows within the payback period is ignored. The larger early cash receipts from project 2 can be reinvested. Unfortunately, all these computation are not considered in payback period.
Step 1: In order to compute the payback period of the equipment, we need to workout the net annual cash inflow by deducting the total of cash outflow from the total of cash inflow associated with the equipment.
Step 2: Now, the amount of investment required to purchase the equipment would be divided by the amount of net annual cash inflow (computed in step 1) to find the payback period of the equipment.
Depreciation is a non cash expense and therefore has been ignored.
According to payback method, the equipment should be purchased because the payback period of the equipment is 2.5 years which is shorter than the maximum desired payback period of the company.
According to payback method, machine Y is more desirable than machine X because it has a shorter payback period than machine X.
Payback period is 4 years because the cumulative cash flow at the end of 4th year becomes equal to initial amount of investment.
Notes:
Cost of capital- is the cost of using funds. When a business uses funds to finance a project, such funds may come from various sources like bonds, notes payable, common stocks, and preferred stocks etc. And we all know that when a company floats bonds or obtain debt to finance a project, it is obliged to pay interest and so as in issuing stocks, it has to pay dividends. This dividends and interest that the company must incur or ay for using funds to finance a project represent the cost of capital.
Conclusion: The project is acceptable because it will yield a return exceeding the minimum desired rate of 8%.
Notes: Let’s say you invest P 100 today and then it will get back P3 Every year, the rate of return is 3% per year.
Notes:
In capital investment decision, companies seek to choose projects that are worth more than what they pay for them, leaving room for economic profit. That is why all these capital budgeting rules are in “>” and “<” signs. Firms would only want to invest in projects when the rate it expects to get is larger than the required rate of return.
Risk aversion is the reluctance of a person to accept a bargain with an uncertain payoff rather than another bargain with a more certain, but possibly lower, expected payoff.
“what-if” analysis. This approaches involves the determination of what happens to NPV estimates when we ask what-if questions.
The decision-maker can develop some plausible scenarios for this purpose. For instance, we can consider three scenarios: pessimistic, optimistic and expected.
Because of the uncertainty of the future, if an entrepreneur wants to know about the feasibility of a project in variable quantities, for example investments or sales change from the anticipated value, sensitivity analysis can be a useful method.
It does not provide clear-cut results. The terms ‘optimistic’ and ‘pessimistic’ could mean different things to different persons in an organisation. Thus, the range of values suggested may be inconsistent.
It fails to focus on the interrelationship between variables. For example, sale volume may be related to price and cost. A price cut may lead to high sales and low operating cost.