Project Risk Conclusions 321
other projects. Table 8-5 also reports a median NPV of $10,607, which means
that half the time the project will have an NPV greater than $10,607. The table
also reports that 72.8 percent of the time we would expect the project to have a
positive NPV.
A picture is worth a thousand words, and Figure 8-2 shows the probability dis-
tribution of the outcomes. Note that the distribution of outcomes is skewed to the
right. As the figure shows, the potential downside losses are not as large as the po-
tential upside gains. Our conclusion is that this is a very risky project, as indicated by
the coefficient of variation, but it does have a positive expected NPV and the poten-
tial to be a home run.
List two reasons why, in practice, a project’s stand-alone risk is important.
Differentiate between sensitivity and scenario analyses. What advantage does
scenario analysis have over sensitivity analysis?
What is Monte Carlo simulation?
Project Risk Conclusions
We have discussed the three types of risk normally considered in capital budgeting
analysis—stand-alone risk, within-firm (or corporate) risk, and market risk—and we
have discussed ways of assessing each. However, two important questions remain:
(1) Should firms be concerned with stand-alone or corporate risk in their capital
budgeting decisions, and (2) what do we do when the stand-alone, within-firm, and
market risk assessments lead to different conclusions?
FIGURE 8-2 NPV Probability Distribution
Probability
–70,000 0 70,000 140,000 210,000
NPV ($)
320 Cash Flow Estimation and Risk Analysis
