Question

- If companies know how to calculate NPV's and IRR's how can they make bad business decisions?

- What elements of the forecast do you think would be hardest to estimate? Why?

- What is the best way to deal with forecasting risk in your analysis?

Answer 1

1. Net present value and internal rate of return are not accurately estimating the cash flows associated with the business and they are not leading to accurate decision-making but they are only approximating the overall acceptance or rejection of a project in the future so they are not providing with complete elimination of risk arising out of bad business decisions out of selection of bad projects.

The weighted average cost of capital which is used for discounting of cash flows are always estimated and approximated whereas,the cash flows are also estimated in relation to various projects so it will always be subject to future changes and it can never be completely accurated in advance so there can be risk related to bad decision making.

2. I think that cash flows associated with future in relation to a particular project will not be easy to estimate and the risk associated with the cash flows are also not easy to estimate so the overall discounting rate will not be completely accurate so the overall cash flows and the discounting rate are subject to fluctuations

3. The best way to deal with the forecasting risk is always to have a risk adjustment in overall projection of the cash flows and discounting rate and always try to do it from a conservative perspective rather than doing it from an aggressive prospective because the risk related to deviations will be higher when we are applying the aggressive perspective.