11-4 Measuring Stand-Alone Risk

A project's stand-alone risk reflects uncertainty about its cash flows. Using the GPC project discussed in previous sections, first-year sales are projected at 10,000 units to be sold at a price of $2.00 per unit (recall that all dollar values are reported in thousands). However, unit sales will almost certainly be somewhat higher or lower than 10,000, and the price will probably turn out to be different from the projected $2.00 per unit. Similarly, the other variables would probably differ from their indicated values. Indeed, all the inputs are expected values, not known values, and actual values can and do vary from expected values. That's what risk is all about! Three techniques are used in practice to assess stand-alone risk: (1) sensitivity analysis, (2) scenario analysis, and (3) Monte Carlo simulation. We discuss them in the sections that follow.

SELF-TEST

What does a project's stand-alone risk reflect?

What three techniques are used to assess stand-alone risk?