Financial Management: Principles and Applications, 13/e

Chapter Summaries

13.1 Explain the importance of risk analysis in the capital-budgeting decision-making process. (pg. 410)

Summary:

The project’s NPV estimate is simply that—an estimate. We perform a project risk analysis of the NPV before making the final accept/reject decision for the following reasons:

• Project cash flows are risky. Our NPV calculation is based on estimates of future cash flows, and the future probably will not look like our estimate. It is very helpful to explore the nature of the risks the project entails so that we can be better prepared to manage the project if it is accepted.

• Forecasts are made by humans, and they can be either too optimistic or too pessimistic. The fact that the analyst may not be totally objective ...