10 Project Cash Flow Estimation and Risk Analysis

Question 1

Cash Flow

Answer 1

amounts of cash that actually flow into or out of the business. some managers tend to overstate revenues and understate costs on most projects, which results in an upward bias in estimated profitability.

Question 2

Incremental cash flows

Answer 2

flows arise solely because of project acceptance

Question 3

terminal value

Answer 3

cash flow assigned to the last year on the timeline of a long-life project to account for the value lost because the cash flows were truncated (cut short).

Question 4

Sensitivity Analysis

Answer 4

process of assessing how changes in one variable affect another variable. example how is NPV affected when the value of input cash flow, such as volume, changes.

Question 5

Scenario analysis

Answer 5

risk assessment technique that overcomes the problems associated with sensitivity analysis. examines the impact of several (often three) economic scenarios on a project’s profitability.The difference between the base case and worst-case NPV (or IRR) gives managers a feel for the riskiness of the project—the greater the difference in these values, the higher the risk. the entire process is easier if three scenarios are used instead of 9.

Question 6

risk-adjusted discount rate (RADR)

Answer 6

risk adjustment method that changes the discount (opportunity cost) rate to reflect the unique riskiness of the project being analyzed

Question 7

Project Cost of Capital

Answer 7

discount rate that reflects the unique riskiness of the project being analyzed,

Question 8

capital rationing

Answer 8

condition of having more acceptable projects than funds (capital) needed to undertake those projects