02.07.01 |【01】| Risk in Investment Appraisal Decisions

⚠ How to deal with risk and uncertainty in investment appraisal ?

ℹ Consider risk premium and payback period…

1️⃣ To compensate for risk — add a risk premium to the discount rate — safety margin — however — the premium may vary from project to project — different levels of risk — some projects lower risks — some projects higher risks.

2️⃣ Difficult to control capital projects over a long period of time — risk may be limited by selecting projects with short payback periods — might induce short-termism while longer-term value-adding projects may be rejected unnecessarily — Estimates of cash flows several years ahead are quite likely to be inaccurate and unreliable.