Page 190 - DMGT405_FINANCIAL%20MANAGEMENT

Financial Management

Notes
Example: The level of sales, the cost of raw materials, labour rates, utility costs and tax
rates.
Risk is associated with the variability of future returns of a project. The greater the variability of
the expected returns, the riskier the project. Risk can however be measured more precisely. The
most common measures of risk – standard deviation and co-efficient of variations – are discussed
later, in this unit.

Notes Risk Analysis in Practice in India

 Most companies in India account for risk while evaluating their capital expenditure
decisions. The following factors are considered to influence the riskiness of investment
projects:
 Price of raw material and other inputs
 Price of product
 Product demand

 Government policies
 Technological changes
 Project life

 Inflation
 Out of these factors, four factors thought to be contributing most to the project
riskiness one selling price – product demand, technical changes and govt. policies.

 The most commonly used methods of risk analysis in practice are: sensitivity analysis,
conservative forecasts include using short payback or higher discount rate for
discounting cash flows.

 Except a very few companies, most companies do not use the statistical and other
sophisticated techniques for analyzing risk in investment decisions.

Self Assessment

Fill in the blanks
12. In the context of capital budgeting, the term………., refers to the chance that a project will
prove unacceptable.

13. Risk is associated with the …………….of future returns of a project.
9.7 Conventional Techniques to Handle Risk

The following are conventional techniques to handle risk in capital budgeting:

 Payback
 Risk adjusted discount rate
 Certainty equivalent
These methods are simple, familiar and partially defensible on theoretical grounds.

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