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Is the confidence level selected randomly? Are we to just pick anyone between 1, 5, and 10%? If 2.33 is for 1% and 1.645 for 5%, Pilot question 3 picked 1.645 at 98% confidence level which is the same as 95% confidence level. Is there a range? How do i know which one to pick?
Thank you for your assitance
Unless the question states a confidence level, then you should choose either 95% or 99% (in theory you could actually choose other %’s, but 95% and 99% are the standard ones). Obviously, in your answer state which confidence level you have chosen.
I am a bit puzzled by you writing 98% – the answer has chosen the 95% level (not 98%).
So what does this mean:
” this suggests that this project has a 97.3 per cent probability that it will have a positive net present value or conversely a 2.7 per cent probability of a negative net present value ……………
At the 98% level std dev = 1.645 giving
Project VaR = 1.645 x $1.02m x 3.162 = $5.3 million”I am equally puzzled.
I sure it did not say that when I last looked at the examiners answers!
But the ACCA website is having problems (again) and so I will have to check later and let you know.
(Are you looking at the answer from the ACCA website, or an answer in a Revision Kit – if it is in a revision kit then there could be a typing error)This is the examiners answer – it does not mention 98%!
(the 97.3% you mention is working backwards, but you do not need to do this)Unlike the assessment of the probability of the project failing to generate a positive net present value given above, VaR measures the value which could potentially be lost by the business, over the project life time, given the volatility of the net present value. The project value at risk is based upon an assessment of the number of years that the project cash flow is at risk (10), the annual volatility and the confidence level required by the firm. VaR assumes that the net present value of the project is normally distributed and thus there is the potential, in theory at least, for those losses to be unlimited. The application of the confidence level of 95% places a level of potential loss that the firm will consider in its project evaluation processes whilst recognising that there is a one in twenty chance that the loss could turn out to be greater. The formula for project VaR is:
?projectVaR = N(0.95)??T projectVaR = N(0.95)s T
?projectVaR = 1.645×1.02×3.162 = $5.3million projectVaR = 1.645×1.02×3.162=$5.3million
This assumes a 95 per cent confidence level, at 99 per cent the project VaR is $7.51 million. This value reflects the fact
41.798
that the c1a0pital invested is at risk for ten years and assumes that the volatility of the project is fairly represented by the MIRR = 17.396 -1
volatility of its net present value.
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