12 As general rule of thumb, financial breakeven is a higher hurdle, Because it requires the firm to make sufficient revenues to cover the hurdle rate on the funds invested in the project.
13
14
15
16 If outcomes are more continuous than discrete, then scenario analysis will not work. More likely to be effective in cases with discrete outcomes.
17
18
19
20 At t=0, conduct $500,000 study of market potential. Stage 2 If it appears there is a significant market (probability =0.8), spend an additional 1,000,000 for marketing test. Stage 3 If reaction is good, build larger plant for $10,000,000. Project is expected to last for 4 years, before patent expires.
21
22
23
24 Project-Specific Risk Risk that matters only to the project under consideration. May arise from factors specific to the project. Competitive Risk Unanticipated effect (positive or negative) on the cash flows of project arising fromcompetitor’s actions Industry -Specific Risk Unanticipated effect (positive or negative) on the cash flows of project due to industry-wide shifts in technology, changes in law, commodity prices. International Risk Additional uncertainty in cash flows created by unanticipated changes in exchange rates and by political risk in foreign markets. Market Risk Unanticipated change in project cash flows created by changes in interest rates, inflation, and the economy
25
26 Firm’s risk measure: If project risk is constant across the firm IE, the overall cost of equity for the firm would be used as the cost of equity for the project Project risk measure IF project risk varies across projects. Implies cost of equity will be different for different classes of projects, or for different divisions.