5. Measuring stand-alone risk

When projects involve certain, or constant, cash flows, the capital budgeting analysis that can be conducted is very simple and straightforward. Unfortunately, this type of project rarely exists.

When a projects cash flows, or the conditions that affect their magnitude or timing, vary from their expected values, then the analysis becomes more complicated. Projects that have the potential to exhibit greater or lesser levels of risk than the firms average, or normal, level means that adjustments should be made to the capital budgeting analysis process.

Several techniques are used to assess the stand-alone risk, which reflects the uncertainty about the projects cash flows. Some of these techniques are: (1) sensitivity analysis, (2) scenario analysis, and (3) Monte Carlo simulation.

When a firm is performing a sensitivity or a scenario analysis on a project, it will generate a __________ when it uses the most likely values for its key variables in its calculations. A. Best-case scenario B. Best case NPV

When performing scenario analysis, the expected net present value (NPV) __________ the base-case NPV. A. Will rarely equal to B. Will always equal to