ANALYSIS OF RISK AND UNCERTAINTY

EVALUATION The certainty-equivalent approach has the merit of being simple to calculate. Another merit of this approach is that it incorporates risk by modifying the cash flows which are subjects risk. It is, therefore, conceptually superior to the time-adjusted...
ANALYSIS OF RISK AND UNCERTAINTY

Accept-Reject Rule The decision-criterion here can either be the NPV method or the IRR method. Using the NPV method, the proposal would be accepted if the NPV of the certainty-equivalent cash flow is positive, otherwise it would be rejected. If the IRR method is...
ANALYSIS OF RISK AND UNCERTAINTY

Present Value Calculation After the expected cash flows have been converted into certainty equivalents, the second step under this approach is to calculate their present values. The rate of discount used for the purpose is the risk-free rate or the rate which...
ANALYSIS OF RISK AND UNCERTAINTY

Comparable Riskless Flow As already observed, the incorporation of risk in capital budgeting analysis is done, according to this approach by modifying the expected cash inflows. The first , therefore, involves the determination of the basis for modifying the cash...
ANALYSIS OF RISK AND UNCERTAINTY

Certainty-Equivalent Approach The certainty-equivalent approach (CEA), as an alternative to the risk-adjusted rate method, overcomes some of the weaknesses of the latter method. Under the former approach, the riskiness the project is taken into consideration by...
ANALYSIS OF RISK AND UNCERTAINTY

Evaluation The Risk-adjusted Discount Rate Approach to incorporate risk in the capital budgeting analysis has certain virtues. First, it is simple to calculate and easy to understand. Moreover companies in actual practice apply different standards of cost of capital...