Project Investment Analysis and Risk

The assignment requires students to evaluate an investment project and determine its overall return and associated risks. It calls for the application of financial analysis techniques and concepts to assess the feasibility and potential profitability of the project. Students need to consider factors such as initial investment costs, expected cash flows, discount rates, and risk mitigation strategies.

Running Head: Corporate Financial Accounting
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Project Report: Corporate Financial Accounting

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Contents
Introduction.......................................................................................................................3
Sensitivity analysis...........................................................................................................3
Scenario analysis..............................................................................................................5
Break even analysis..........................................................................................................7
Simulation techniques.......................................................................................................8
Conclusion........................................................................................................................9
References.......................................................................................................................11

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Introduction:
Capital budgeting is a part of investment appraisal techniques. This planning process
is used by the companies to evaluate the various investment long term opportunities. Capital
budgeting process evaluates the various projects according their cash flows, present value
factors, their net present value, internal rate of return, payback period, accounting rate of
return etc (Zimmerman and Yahya-Zadeh, 2011). long term investment opportunities for a
business could be new products, new plants, replacement of old machineries, new machinery,
research development projects etc. for analyzing the best project, company takes the help of
various tools which are available such as sensitivity analysis, scenario analysis, break even
analysis, simulation technique analysis (Bierman and Smidt, 2012). It is required for every
organization to evaluate the best investment proposal from the available proposals. And this
could only be possible if the best corporate decision strategies have been adopted by the
company.
Corporate decision making is a process which aids the organization into looking over
various aspects and then makes a best decision for every dilemma of the business. Corporate
decision making is a continuums process which takes place at every step in an organization.
Corporate decision making sets a companionship among all the factors of the company and
the stakeholders of the company (Gervais, Heaton and Odean, 2011). This report tells the
user about various techniques and analysis which would aid the organization to select the best
investment proposal according to the requirement of the company.
Sensitivity analysis:
Sensitivity analysis is a tool which is used by the various parties to evaluate that how
many diversified values of a free variable would affect a specific variable which has been

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estimated through many assumptions. This analysis is also known as “what if” analysis. It has
been observed that normally, every entire quantitative factor of an investment such as cash
outflow, cash inflow, discount rate, cost of capital, project duration etc are recognized with
certainty but in reality, it rarely takes place (Bierman and Smidt, 2012). Sensitivity analysis
helps the companies to overcome the same problem. The techniques of sensitivity analysis
could be applied over various planning activities and not only on capital budgeting decision.
This analysis helps an organization into evaluating that how the distribution of
possible internal rate of return and net present value for a proposal under context is impacted
consequently to make a change into a single variable which is dependent in nature. This
analysis could take place only be changing into one variable at a time. Sensitivity analysis
evaluates a value for every input and offers a decision making process to the company to
choose the best project. Such as if a product’s selling price would be reduced by 10% and at
the same time, the internal rate of return would also be changed due to changes into the total
life of the project from 3 years to 5 years. Than sensitivity analysis, helps the organization to
make a better decision about investment (Bennouna, Meredith and Marchant, 2010).
As according to the above case, every factor will be changed due to change into a
single variable of the investment proposal. Such as changes into the selling price will change
the NPV of the project and the total life of the project will make an impact over the internal
rate of return. Than the calculated NPV is plotted into a graph to depict that how sensitive the
net present value could be due to changes into the related factors. The below figure depict
that the slope of line in the below graph depicts that how sensitive the net present value is to
make a change into each input. The steeper the slope would be, the more sensitive the net
present value would be to make changes into the variable.

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(Hall and Millard, 2010)
Sensitivity analysis is used widely because of its ability and simplicity to focus over
the specific estimates. Mainly it is used in the banking industry to evaluate the projects which
are related to the funding. This analysis offers critical idea about the success or failure of the
project.
Scenario analysis:
It has been observed that the sensitivity analysis is used widely as a risk analysis
technique but this analysis has some limits. Therefore, sensitivity analysis has been extended
to deal with various probability distributions of various inputs and further, scenario analysis
also aids the more variables at a single time so that the combined effect could also be
analyzed with the changes in more than one variable (Adair, 2011).
Scenario analysis also offers a specific answer to this solution. Scenario analysis
mainly answers the question of that how bad can a project look. Various times, mangers just
take an assumption and forget to make other assumptions according to the competitor’s
relation and economy consideration etc. in scenario analysis; factors are evaluated according
to the scenario which has been built by the managers. These aspects could range from
economy state to the competitor’s response on firm’s any action. Secondly, the components
are determined the number of scenario analysis for every factor. Basically, three scenarios are
determined according to the base, average and worst case. Though, it might vary according to

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the long range (Garrison, Noreen, Brewer and McGowan, 2010). The third component of
scenario analysis is to focus over the critical aspects and build a scenario for every factor and
lastly, in the forth component, probabilities of each scenario are evaluated. This scenario
could be based upon many macro factors such as interest rate, exchange rate and various
micro factors such as reaction of competitor.
Factors Normal case Best case Worst case
Yield - + 20% 30%
Exchange rate - + 5% 5%
Transportation
cost
- -15% +25%
Marketing cost - -8% +23%
Sales cost - + 5 % 15%
Sales price 1.03 1.05 1.00
Cash inflow 10 % 19 % 3%
NPV 1 2.5 -2.3
(Burns and Walker, 2015).

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The above tale depict that the three scenarios are there for every investment proposal
in front of the company, through this analysis, it has been found that the three scenarios are
available in front of the company which are best, normal, worst. Through this scenario, it
becomes easy for the managers to choose the best investment proposal.
Break even analysis:
Break even analysis helps an organization into selecting the best project according to
the cost and revenue relationship. In this project, various tools of an investment proposal are
determined and then the level of breakeven is analysed. The breakeven level of an investment
project is the point where the total associated cost is equal to the total revenue earned by the
company. This analysis a graph is plotted and the total revenue slope and the cost slope are
drawn. The point where both the slopes are interacted with each other is the point of
breakeven (Shim, Siegel and Shim, 2011). Break even analysis generates an idea about the
positive return from an investment. This analysis depict that the fixed cost of a project s not
directly linked with the production level and thus the breakeven level get impacted through
the fixed cost of the project. In addition, variable cost of a project directly makes a change
into the volume of output.
The study of breakeven analysis is a great tool to identify the relationship between the
returns, variable cost and fixed cost. Breakeven point offers an idea that when an investment
proposal would generate positive return as well as it could be determined according to some
mathematical calculations and graph (Grant, 2016). This analysis helps an organization to
calculate the level of production through which the positive returns could be earned by the
company. And the entire cost could be concerned properly.

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(Bodie, 2013)
The above graph of breakeven point depict that the total 9 units are required to be
produce by the company to cover all the cost. Further, production would help the company to
make profits. These calculations help the company to identify the best available project in the
market. And this analysis also help the company to determine the total return which could be
get by the company after investing into the particular project. Further, it has also been
analyzed that how much cost would be paid by the company even in the case of no
production and how much units are required by the company to produce to reach over a point
where the cost and the revenue are equal (Fortson, 2011).
Simulation techniques:
This analysis is also known as Monte Carlo simulation. It ties sensitivity as well as
probability distribution together. This method is based upon various mathematical
calculations. The main fundamental appeal of this technique is to offer decision makers along
with a probability distribution of net present value’s rather than an only single estimation
about the estimated net present value. This technique ties all the related factors and then
makes a corporate decision about the various investment opportunities for an organization.
Firstly, in this analysis, a simulation exercise takes place to investigate over the
investment proposal and than many related key factors are involved to estimate the affected

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project and their inter relationship with other factors. This technique involves modelling of
cash flows to disclose entire key factors which are influenced by both the cash payments and
receipts and their relationship with other factors.
Simulation technique involves the relationship of net present value with various
parameters and exogenous variables. It specifies the parameters value and probability
distribution of exogenous factors and variables. Further, a value is selected randomly from
probability distribution of every exogenous variable. In addition, NPV is determined
corresponding to the random generated value of variables and pre specified variables of
parameters. The 3rd and 4th steps are repeated again to get a large number of simulated net
present values (Wright et al, 2010). Lastly, the probability distribution is plotted and mean
and standard deviation of return are computed to collect the risk level of a project.
Simulation techniques are analyzed to determine the best investment project form the
various available projects in the market. This analysis mainly shows its concern about the
probability distribution and the sensitivity analysis. This study helps the organization to
identify and evaluate the best available investment proposal from the available projects into
the company (Godfray et al, 2010). This analysis aids the company to evaluate the best
business plan for the company in concern of the profits. This analysis technique is a tool
which is mainly uses by the association to make a superior decision about diverse
investments i.e. the total time in which corporation would be proficient to reverse the entire
connected cost.
Conclusion:
In the above study, capital budgeting technique has been investigated and it has been
found that this planning process is used by the companies to evaluate the various investment
long term opportunities. Capital budgeting process evaluates the various projects according

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their cash flows, present value factors, their net present value, internal rate of return, payback
period, accounting rate of return etc. for this study, various tools such as sensitivity analysis,
scenario analysis, break even analysis, simulation technique analysis have been analyzed and
it has been found that all the analysis are helpful for the company to identify the best project
from the available projects.
Through this study, it has been found that all the projects are helpful for the company
in diverse situation. Sensitivity analysis is a tool which is used by the various parties to
evaluate that how many diversified values of a free variable would affect a specific variable
which has been estimated through many assumptions. Scenario analysis mainly answers the
question of that how bad can a project look. Various times, mangers just take an assumption
and forget to make other assumptions according to the competitor’s relation and economy
consideration etc. In addition, Break even analysis helps an organization into selecting the
best project according to the cost and revenue relationship. In this project, various tools of an
investment proposal are determined and then the level of breakeven is analysed. Lastly, a
simulation exercise takes place to investigate over the investment proposal and than many
related key factors are involved to estimate the affected project and their inter relationship
with other factors. And these analyses help the company to determine the total return and risk
which could be faced by the company after investing into the particular project

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References:
Adair, T., 2011. Corporate Finance Demystified 2/E. McGraw Hill Professional.
Bennouna, K., Meredith, G.G. and Marchant, T., 2010. Improved capital budgeting decision
making: evidence from Canada. Management decision, 48(2), pp.225-247.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
Bodie, Z., 2013. Investments. McGraw-Hill.
Burns, R. and Walker, J., 2015. Capital budgeting surveys: the future is now.
Fortson, J.G., 2011. Mortality risk and human capital investment: The Impact of HIV/AIDS
in Sub-Saharan Africa. The Review of Economics and Statistics, 93(1), pp.1-15.
Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial
accounting. Issues in Accounting Education, 25(4), pp.792-793.
Gervais, S., Heaton, J.B. and Odean, T., 2011. Overconfidence, compensation contracts, and
capital budgeting. The Journal of Finance, 66(5), pp.1735-1777.
Godfray, H.C.J., Beddington, J.R., Crute, I.R., Haddad, L., Lawrence, D., Muir, J.F., Pretty,
J., Robinson, S., Thomas, S.M. and Toulmin, C., 2010. Food security: the challenge of
feeding 9 billion people. science, 327(5967), pp.812-818.
Grant, R.M., 2016. Contemporary Strategy Analysis Text Only. John Wiley & Sons.

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Hall, J. and Millard, S., 2010. Capital budgeting practices used by selected listed South
African firms. South African Journal of Economic and Management Sciences, 13(1), pp.85-
97.
Shim, J.K., Siegel, J.G. and Shim, A.I., 2011. Budgeting basics and beyond (Vol. 574). John
Wiley & Sons.
Wright, M.M., Daugaard, D.E., Satrio, J.A. and Brown, R.C., 2010. Techno-economic
analysis of biomass fast pyrolysis to transportation fuels. Fuel, 89, pp.S2-S10.
Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control.
Issues in Accounting Education, 26(1), pp.258-259.