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Risk analysis in capital budgeting
1. Risk Analysis in Capital
Budgeting
By: Vikram.G.B
Lecturer, P.G dept. of Commerce
V.D.C, Bangalore-55
2. Risk & uncertainty:-
β’ Uncertainty is a situation where a decision can
lead to more than one possible outcome.
β’ Risk exists because of the inability of the
decision maker to make perfect forecast.
β’ Traditional difference between Risk &
Uncertainty is
β« uncertainty can't be quantified whilst risk can.
3. β’ Risk is concerned with the use of quantification
of the likelihood of future outcomes.
β’ Uncertainty is to cover all future outcomes
which cannot be predicted with accuracy.
4. Why Risk Arises in Investment Evaluation?
β’ Because unable to anticipate occurrence of the
possible future events with certainty and
consequently.
β’ Unable to make correct prediction about the
cash flow sequence.
6. Systematic Risk:-
β’ It relates to economic trend whichs affect the
whole market.
β’ It is a that portion of variation in return caused
by the factors that affect the prices of all
securities and it canβt be avoided.
β’ The effect in a systematic return causes the
prices of all individual shares/bonds to move in
the same direction.
7. Reasons for occurring of Systematic Risk
β’ Market Risk: Variations in price sparked off due to
real social, political and economic events.
β’ Interest Rate Risk: Uncertainty of future market
values and the size of future incomes, caused by
fluctuations in the general level of interest.
β’ Inflation Risk: It is referred to uncertainties of
purchasing power due to inflation.
8. Unsystematic Risk:-
β’ It is that portion of risk which is caused due to
factors unique or related to a firm or industry.
β’ This type of risk can be eliminated by
diversification of portfolio.
9. Reasons for occurring of unsystematic Risk
β’ External Business Risk: It arises due to change
in operating conditions caused by conditions
thrust upon the firm which beyond its control.
β’ Internal Business Risk: It is associated with the
efficiency with which a firm conducts its
operations within the broader environment
imposed upon it.
10. β’ Financial Risk: It is associated with the capital
structure of a firm.
ο The extent of financial risk depends on the leverage
of the firmβs capital structure.
11. Investorsβ Attitude to Risk:-
β’ Common investors will have 3 possible attitudes to
undertake risky course of action
β« An aversion to risk.
β« A desire to take risk.
β« An indifference to risk.
