Statement - II : Sensitivity Analysis helps in calculation of net present value of the proposal.
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This question requires evaluating two statements related to financial investment appraisal techniques.
Statement I: Payback Period and Risk Adjustment
The payback period method calculates the time needed to recover the initial investment from a project's cash flows. In practice, higher project risk implies greater uncertainty about future cash flows. To mitigate this risk, a shorter payback period is often targeted. A shorter target implies the investment must become profitable more quickly, thus reducing the time the capital is exposed to potential risks. Therefore, adjusting the risk by lessening the target payback period is a valid approach within this method.
Conclusion: Statement I is correct.
Statement II: Sensitivity Analysis and Net Present Value (NPV) Calculation
Sensitivity analysis is a technique used in financial modeling to determine how different values of an independent variable impact a specific dependent variable under a given set of assumptions. In the context of project evaluation, sensitivity analysis examines how changes in key variables (like sales volume, costs, or discount rate) affect the project's financial metrics, such as the Net Present Value (NPV).
While sensitivity analysis helps assess the *impact* of variable changes on the NPV and understand its *variability* or *sensitivity*, it does not *calculate* the NPV itself. The NPV is calculated independently using discounted cash flows. Sensitivity analysis is performed *after* the NPV has been calculated to test its robustness.
Conclusion: Statement II is incorrect.
Final Assessment
Based on the analysis:
- Statement I is correct.
- Statement II is incorrect.
This corresponds to the option where Statement I is correct and Statement II is wrong.
Important Questions from Capital Budgeting
- Assume B is social benefits, C is social costs, r is the social discount rate, t is the time and T is the life of the investment project. The Net Present Value (NPV) of a project is
- In certainty-equivalent approach, risk adjusted cash flows are discounted at
- Which one of the following equates the present value of cash out flows and the present value of expected cash inflows from a project ?
A public works project is proposed that has total present-worth benefits of ₹ 75 million and total present-worth cost of ₹ 55 million. In deliberating this proposal, some members of the Municipal Board have suggested that the project has a total present-worth disbenefits of ₹ 15 million; other members feel that ₹ 15 million should be treated as a cost. What will be the benefit cost ratio and net benefits value while considering the disbenefits as a cost?
Select the correct statement/s from the following :
Statement I : The slope of the NPV profile reflects how sensitive the project is to discount rate changes.
Statement II : To find total NPV of more than one projects, their NPV cannot be added.
Statement III : The certainty equivalent coefficient applies adjustments to both, the cash flows (in the numerator) and the discount factor (in the denominator).
Statement IV : The risk - adjusted discount factor applies adjustment for risk only to the discount factor (denominator).
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