FIN302-Cash Flow Uncertainty (exam 2)

FIN302-Cash Flow Uncertainty (exam 2) - How to Handle Cash...

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How to Handle Cash Flow Uncertainty From Chapters 9 and 10
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How do you account for error in predictions? Remember: You should calculate the discount rate to the best of your ability Account for errors in forecasting in your cash flows, not your discount rate
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Simple First Step: Allowing for Possible Bad Outcomes Example Project Z will produce just one cash flow, forecasted at $1 million at year 1. It is regarded as average risk, suitable for discounting at a 10% company cost of capital: But how do we find the $1,000,000 estimate? 100 , 909 $ 1 . 1 000 , 000 , 1 1 1 = = + = r C PV
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Allowing for Possible Bad Outcomes Example- continued But now you discover that the company’s engineers are behind schedule in developing the technology required for the project. They are confident it will work, but they admit to a small chance that it will not. You still see the most likely outcome as $1 million, but you also see some chance that project Z will generate zero cash flow next year.
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Allowing for Possible Bad Outcomes Example- continued This might describe the initial prospects of project Z. But if
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