Risk analysis, Real options and Capital budgeting H8 Flashcards
What is the main critique against Net present value
That it gives managers a false sense of security
What is sensitivity analysis
When a project is evaluated on how much its value changes when a selected variable changes.
What is scenario analysis
Looking at how the value of a project will change in different scenarios f.ex if war breaks out
What are some other names of sensitivity analysis
BOP (best optimistic pesimistic) analysis or what if analysis
Sensitivity analysis shows where more research is needed
True, if some variables are very sensitive the firm probably needs to really make sure that it does not turn bad if they want to take on the project
What are the three weaknesses of sensitivity analysis
It might be difficult to eveluate what the best and worst cases are for the variables, they may make managers overcomfident if the project is positive even in the worst case and it can only look at one variable at once.
What is the break even poing
The amount of sales required for the project to make no profit nor loss
What is the conttribution margin
Sales price - variable costs, the amount of money a sale can at most contribute to profits
Can a company that breaks even on an accounting basis be loosing money.
In a way yes if they are not taking cost of capital into account.
Explain monte carlo analysis and its five steps
It is a type of project forecast which takes inspiration of how ods are calculated at casinos hence the name. First step one the basic model of earnings and costs is created, then as number two a probabiity distribution of scenarios is made fore each variable in the model, then as number three a computer generates a scenario and step for is just repeat the process untill all scenarios are covered, lastly as 5 you calculate the NPV of the average.
What are real options
Adjustments to a project that a company can do after it is created
Name some real options
Option to expand, abandon and timing options
What is a decision tree and how do you use them to eveluate options
A devision tree is a way to structure different scenarios where each branch has its own probablity. You evaluate the options by multiplying the NPV in each scenario by its likelihood.
