February 2022
Intermediate to advanced
1040 pages
34h 38m
English
Content preview from Corporate Finance, 6th Edition
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Chapter 30RISK AND INVESTMENT ANALYSIS
When uncertainty creates value …
Valuing an investment by discounting future free cash flows at the weighted average cost of capital can provide some useful parameters for making investment decisions, but it does not adequately reflect the investors' exposure to risk. On its own, this technique does not take into account the many factors of uncertainty arising from non-financial investments.
As a result, many risk analysis methods have been developed. However, these methods have limitations that only a radically different approach seeks to overcome. We will see that the application of option theory to investment choice theoretically offers this possibility. Although it brings decisive concepts to risk analysis in investment, it is far from being frequently applied, often for good reasons.
Section 30.1 ASSESSING RISK THROUGH THE BUSINESS PLAN
1/ BUILDING A BUSINESS PLAN
The reader must realise that the business plan is the first stage in assessing the risks related to an investment. The purpose of the business plan is to model the firm's most probable future, and it helps to identify the parameters that could significantly impact on a project's value. For example, in certain industries where sales prices are not very important, the model will be based on gross margins, which are more stable than turnover.
Establishing a business plan helps to determine the project's dependence upon factors over which investors have some influence, ...
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