Financial Management: Principles and Applications, 13/e

13.2 Tools for Analyzing the Risk of Project Cash Flows

The actual cash flows an investment produces will almost never exactly equal the expected cash flows used to estimate the investment’s NPV. There are many possible cash flow outcomes for any risky project, and simply specifying a single expected cash flow can provide a misleading characterization of the investment. Although it is generally impossible to specify all possible outcomes, an analyst can use some basic tools to examine the uncertain nature of future cash flows and, consequently, the reliability of the NPV estimate.

The first tool we will consider is sensitivity analysis, which helps the analyst identify the most important forces that ultimately determine the success or failure ...