chapter 14Risk and Managerial Options in Capital Budgeting(财务管理,Gregory A. Kuhlemeyer).ppt

Chapter 14 Risk and Managerial Options in Capital Budgeting Risk and Managerial Options in Capital Budgeting The Problem of Project Risk Total Project Risk Contribution to Total Firm Risk: Firm-Portfolio Approach Managerial Options An Illustration of Total Risk (Discrete Distribution) ANNUAL CASH FLOWS: YEAR 1 PROPOSAL A State Probability Cash Flow Deep Recession .05 $ -3,000 Mild Recession .25 1,000 Normal .40 5,000 Minor Boom .25 9,000 Major Boom .05 13,000 Probability Distribution of Year 1 Cash Flows Summary of Proposal A The standard deviation = SQRT (14,400,000) = $3,795 The expected cash flow = $5,000 An Illustration of Total Risk (Discrete Distribution) ANNUAL CASH FLOWS: YEAR 1 PROPOSAL B State Probability Cash Flow Deep Recession .05 $ -1,000 Mild Recession .25 2,000 Normal .40 5,000 Minor Boom .25 8,000 Major Boom .05 11,000 Probability Distribution of Year 1 Cash Flows Summary of Proposal B The standard deviation of Proposal B Proposal A. ( $2,846 $3,795 ) Total Project Risk Projects have risk that may change from period to period. Projects are more likely to have continuous, rather than discrete distributions. Probability Tree Approach A graphic or tabular approach for organizing the possible cash-flow streams generated by an investment. The presentation resembles the branches of a tree. Each complete branch represents one possible cash-flow sequence. Probability Tree Approach Each node in Year 2 represents a branch of our probability tree. The probabilities are said to be conditional probabilities. Joint Probabilities [P(1,2)] .02 Branch 1 .12 Branch 2 .06 Branch 3 .21 Branch 4 .24 Branch 5 .15 Branch 6 .02 Branch 7 .10 Branch 8 .08 Branch 9 Project NPV Based on Probability Tree Usage The probability tree accounts for the distribution of cash flows.