Stand Alone Risk and Capital Projects

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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.

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