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Risk can be quantified by attaching probabilities (based on past experience) to the possible outcomes of a project. The methods to incorporate risk are:
1. Sensitivity analysis
2. Probability analysis – Expected value
3. Using risk-adjusted discount RATE – To get a short payback period
4. Adjusted payback PERIOD
5. CAPMUncertainty can not be quantified, therefore can not be considered due to measurement issue. There it is simply ignored in F9.
Please check if there is any correction needed in the summary. I summarized in my words what I studied in this chapter.
Thanks,
Sensitivity analysis does not depend on probabilities – it identifies those flows for which uncertainty is more critical.
Expected values do deal with risk (but not with uncertainty).
Risk-adjusted discount rate is nothing to do with the payback period – it is another word for CAPM (which does deal with risk).
Payback period deals with uncertainty – the shorter the payback period then the less we are worried about uncertainty because it is later flows that will be more and more uncertain.
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