Risk Models/Formulas Flashcards
Probability assumptions
Outcome is %, real life is yes or no
Probability index formula?
PI = PV of future CF/Investment
What is a divisible probability?
can be % of projects
What is a indivisible probability?
All or nothing, use trial and error to rank
What is capital rationing?
There is limited cash to invest in +NPV.
Hard - external
Soft - internal
Sensitivity analysis formula
NPV/PV of variable
What is sensitivity analysis?
How much a variable (e.g. sales) would need to change to breakeven NPV
Advantages and disadvantages of sensitivity analysis
Advantages:
It identifies the most critical variable for NPV to breakeven
Disadvantages:
Only looks at one variable at a time
Does not tell the likelihood
Equivalent Annual Cost formula
PV of costs/Annuity
What is EAC?
How often to replace asset
Work out EAC for both options and choose cheapest NPV
What is conservative forecasting?
Worst case scenario, use risk free rate (COVID)
What is simulation?
Random numbers
What is scenario analysis?
Recession - stable/boom
Discounted (adjusted) payback
Use NPV figures (discounted) - make the payback shoerter
Factors of risk?
Quantifiable
Probabilities
Simulation
Conservative forecasting
