- This topic has 3 replies, 2 voices, and was last updated 7 years ago by
.
- Posts
Sir there was a question that critically discuss the use of probability analysis in incorporating risk into investment appraisal?
Sir in the examiner’s answer, before going on limitations, he has wrote that
Probability analysis can be used to calculate the values of possible outcomes and their probability distribution, the value of the worst possible outcomes and its probability, the probability that an investment will generate a positive NPV, the standard deviation of the possible outcomes and the expected value of the NPV.
Sir can I replace the above paragraph with the following below paragraph OR is it necessary to write the above paragraph?
Probability analysis incorporates risk by converting different possible outcomes into 1 single expected outcome called Expected value and is based on the idea that if more options are considered , risk is minimized.
The first part of your statement is correct. However expected values do not minimise risk – they ignore it, as I explain in the lecture.
(You do not need to mention standard deviation – that is not in the syllabus – but you do need to mention that expected values ignore the variation in the possible returns (again, as I explain in the lecture))
Sir for the past exam question which is of 5-6 marks that Critically discuss the use of probability analysis in incorporating risk into investment appraisal?
Is writing the below answer fine and correct?Probability analysis incorporates risk by converting different possible outcomes into 1 single expected outcome called Expected value.
It can be used to calculate the values of possible outcomes and their probability distribution, the value of the worst possible outcomes and its probability, the probability that an investment will generate a Negative NPV. However there are certain limitations of Probability
analysis.1)The EV is merely a weighted average of the probability distribution, indicating the average payoff if the project is repeated many times.
2)The EV gives no indication of the dispersion of possible outcomes about the EV. The bigger the spread of possible outcomes are, the more risky the investment is seen to be.
3) Probabilities used are very subjective
- The topic ‘Probability analysis’ is closed to new replies.