Uncertainty and risk A project analyst estimates that a proposed project will ha
ID: 2761682 • Letter: U
Question
Uncertainty and risk A project analyst estimates that a proposed project will have an expected return of 16%, which is higher than the Minimum Acceptable Rate of Return demanded by the corporation. He decides to also conduct a study of the uncertainties of a project and arrives at the conclusion that the project will have the following possible returns:
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Return & P(return)
8% 3.85%
10% 9.62%
12% 17.31%
14% 13.46%
16% 18.27%
18% 17.31%
20% 10.58%
22% 3.85%
24% 5.77%
The analyst submits his recommendation to the board that the project should not be undertaken, even though it is expected to provide a return greater than the MARR. Why do you think that this might be the case? Under what conditions this decision might be warranted? Under what conditions might the analyst's position be overturned?
Explanation / Answer
Accepting a project with high risk is always a tricky situation. Various attributes of the projects need to be analysed and assessed. All the risky projects come with high returns too. If it is a success, returns outweigh the risks however some times if the risk is much higher, the project can turn the firm out of business too.
The decision to take the project or not will depend on the following aspects
Sometimes such calculated risks need to be re-assessed and management should decide not to take the decision.
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