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Risks related to capital budgeting

what is risk take 2 what the probability that some

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Unformatted text preview: ll cause an undesirable outcome on the financial health of your business and/or other business/family goals Components of Risk Components Surplus Produc tion t es erest ra int reasing Inc Hail EVENT Cause/Source Currency risk Disablin g farm acciden t Probability of 5% Probability of 15% Probability of 60% Probability of 15% Probability of 5% Potential Outcome #1 Potential Outcome #2 Potential Outcome #3 Potential Outcome #4 Potential Outcome #5 [minor nuisance] [catastrophic] Components of Risk – Undesirable Outcome Undesirable Put simply, the Undesirable Outcome is what hurts! Den ied X - lower than expected production - catastrophically lower production - inability to meet cash flow - loss of income - catastrophic loss of income - loss of life - loss of buildings & other resources - loss of health - inability to get a permit or loan Components of Risk – Event (Cause/Source of Risk) Event The Event is what caused the hurt: - weather event - injury/death of an employee - neighbors action against you - surplus production of milk - widespread poor grain production - low quality inputs - divorce or disagreement - downward slide in general economy - and countless more!!! Components of Risk – Probability Probability Probability is a measure of the likelihood that the Risk Event will occur, e.g., 30% chance of rain 100 60 40 20 18 17 16 15 14 13 12 11 10 8 A 9 B C 7 0 6 Percent 80 Five Primary Means of Risk Management Risk Reduce 1. Reduce the probability that the event will occur 2. Reduce the impact if the event does occur Transfer 3. Transfer the cost of an undesirable outcome to someone else 3. Avoid 4. Completely avoid potential events thus providing a zero Completely probability that they will occur probability Do Nothing 5. Let the risk happen and be ready to bear the consequences. 5. Financial Risk Risk: higher interest rates causing the undesirable higher outcome of lower than expected income/cash flow outcome Risk Management??? Cash Flow Do Nothing 46 46 Financial Risk Risk: higher interest rates causing the undesirable higher...
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