BIS3589_ch12 - • Certainty Equivalent method •...

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Chapter 12 Risk Analysis in Capital Budgeting
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Capital Budgeting   Capital Budgeting: the process of determining how a firm  should  allocate its capital resources  to profitable  long- term investment  opportunities in order to  maximize  shareholder’s wealth
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Risk  The information used in analysis is future expectation.  The actual result may be different from expectation We add some analysis to respond with the uncertainty
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Scenario Analysis  Assume the change in input variable and see the  corresponding output For example, if cost of capital changes to 12%, what will  be NPV? This changes your original decision or not? If expense will increase by 20%, your decision will  change?
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Method in incorporating risks
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Unformatted text preview: • Certainty Equivalent method • Risk-adjusted Discount Rate Method Certainty Equivalent Method • Change future uncertainty cash flow to be certain cash flow by using CE coefficient • CE coefficient ( α ) = the ratio of riskless cash flow by risky cash flow Certainty Equivalent Method • Multiply each future cash flow with estimated CE coefficient • Discount that certainty cash flow by Risk Free Rate Risk-Adjusted Discount Rate • Discount each cash flow with appropriate discount rate • RADR = WACC + risk premium Risk-Adjusted Discount Rate • Adjust WACC with corresponding risk premium to get RADR • Discount that certainty cash flow by RADR...
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This note was uploaded on 01/11/2012 for the course FINANCE fin 3701 taught by Professor Tengihla during the Spring '11 term at Assumption College.

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BIS3589_ch12 - • Certainty Equivalent method •...

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