13.1 The Importance of Risk Analysis
In the previous chapter, we calculated the expected cash flows for a potential investment project, and we then used the investment criteria we studied in Chapter 11 to perform a net present value (NPV) analysis of those cash flows to determine whether the investment would add value to the firm. We also assumed that the cash flows for different projects all had the same level of risk for the firm. However, different projects have different levels of risk, and, as a result, financial managers need to evaluate the risk of a proposed investment project.
There are two fundamental reasons to perform a project risk analysis before making the final accept/reject decision:
Project cash flows are risky. We base our ...
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