Risk Analysis in Capital Budgeting
Capital budgeting is used to ascertain the requirements of the long-term investments of a company. Examples of long-term investments are those required for replacement of equipments and machinery, purchase of new equipments and machinery, new products, and new business premises or factory buildings, as well as those required for R&D plans. The different techniques used for capital budgeting include:
Net present value
Modified Internal Rate of Return
Internal Rate of Return
Besides these methods, other methods that are used include Return on Investment (ROI), Accounting Rate of Return (ARR), Discounted Payback Period and Payback Period.
The different types of risks that are faced by entrepreneurs regarding capital budgeting are the following: Corporate risk:
Corporate risk refers to the liabilities and dangers that a corporation faces. Risk managementis a set of procedures that minimizes risks and costs for businesses. The job of a corporate risk management department is to identify potential sources of trouble, analyze them, and take the necessary steps to prevent losses. International risk
Risk that economic or political changes in a foreign country, for example, lack of currency reserves (Foreign Exchange), will cause delays in loan payments to creditor banks, Exchange Controls by monetary authorities, or even repudiation of debt. Stand-alone risk
The risk associated with a single operating unit of a company or asset. Standalone involves the risks created by a specific division or project, which would not exist if operations in that area were to cease. Standalone risk measures the dangers associated with a single facet of a company's operations or by holding a specific asset. In portfolio management, standalone risk measures the undiversified risk of an individual asset. For a company, standalone risk allows them to...