Stand Alone Risk and Capital Projects
When only a single project is evaluated, then only its stand-alone risk is measured.
The single project in question likely has a range of possible cash flow outcomes, so the company really needs to evaluate risk around these multiple outcomes.
Three methods for measuring Stand Alone Risk:
1. Sensitivity Analysis
This approach focuses on a project’s NPV sensitivity to a single variable. The approach starts with a base case and calculates the change in NPV in the event of a change to an input variable in the NPV calculation.
For example, a firm may want to determine a project’s NPV sensitivity to a change in forecasted sales. The change can be favorable or unfavorable. The analyst may create three NPVs for the project: one with a base sales case, one with a favorable sales case, and one with an unfavorable sales case. The different NPVs will show the project’s sensitivity to a change in sales. The sensitivity can be calculated for any input variable: operating expenses, discount rate/cost of capital, tax rates, depreciation method, or expected salvage value.
Unlock Premium Content
Upgrade your account to access the full article, downloads, and exercises.
You'll get access to:
- Access complete tutorials and examples
- Download source code and resources
- Follow along with practical exercises
- Get in-depth explanations