Investment appraisal Flashcards
1
Q
What is monte carlo simulation?
A
It’s a mathematical model, that helps predict future values.
Uses an drift element (the way the asset moves) and a random element.
Is the result within risk appetite? Helps predict EV’s
2
Q
What is the difference between risk and uncertainty?
A
Risk = outcomes and probabilities are both known Uncertainties = outcomes are known, probabilities are not
3
Q
Considerations w/ NPV?
A
- Correct timescale?
- Assumptions reasonable?
- Tax assumptions?
- Discount rate appropriately estimated?
- Real options considered?
4
Q
Advantages of sensitivity analysis?
A
- Simple
- Identify critical factors
- Helps decision making
5
Q
Weaknesses of sensitivity analysis?
A
- Not realistic to changing one variable at a time
- Doesn’t consider probabilities changing
- Doesn’t tell us the correct decision
6
Q
Two ways to overcome sensitivity analysis weaknesses?
A
- Monte carlo simulation
2. Probability analysis
7
Q
Limitations of replacement analysis?
A
- Tech changes
- Inflation changes
- Tax normally ignored
- Production isn’t perpetual
8
Q
Strengths of expected values?
A
- Information reduced to single number
2. The idea of an average is readily understood
9
Q
Weaknesses of expected values?
A
- Difficult to estimate probabilities
- Average might not correspond to any likely outcome
- Not appropriate for one off choices
- Ignores risk and doesn’t indicate the spread of results
10
Q
Sources of political risk?
A
- Government stability
- Economic stability
- Inflation
- Degree of international indebtedness
- Financial infrastructure
- Import restrictions
- Expropriation
- Taxes and incentives
11
Q
Sources of cultural risk?
A
- Different practices of customers and consumers
- Media and distribution systems
- Different business practices in markets
- National cultural differences
12
Q
What are the real options?
A
FLexibility = CALL Abandonment = PUT Timing = A FLEXIBILITY OPTION
FOllow on = CALL
Growth = RELATED TO FOLLOW ON
