Lecture 9: IRR & Risk

Question 1

Define IRR

Answer 1

• Alternative to NPV
• A.k.a. ‘discounted cash flow rate of return’ (DFCROR)
Find NPV = 0 –> discount rate where project begins to be worthwhile => only at this X or lower discount rate can project generate more income than simple investment at X%

Question 2

Define risks

Answer 2

• Collateralised debt obligations - took large range of debts (mortgages) and aggregated them together

• Scale of potential uncertainties
- Identify factors project critically depend on i.e. selling price, relying on one supplier
- Identify factors which can be quantified
Scale of consequences

Question 3

Risk mitigation strategy?

Answer 3

• identify what project depends on = can it be mitigated i.e. change suppliers
• identify what can be quantified
  => reasonable limits of factors will its change overall economics?
  => do they depend on each other?
  => can risk be reduced?

Question 4

Define types of risk analysis

Answer 4

• use simulators => go through changes and see resulting changes, calculate weighted landscape
• scenario analysis => define scenarios and see how this changes variables
• fluctuation sensitivity => simulate random fluctuations in variables to measure how outcomes would vary

Question 5

How is risk minimised

Answer 5

• understand project better
• use best data
• be open minded and critically creative
• knowledge of other broad areas