Question

Describe a decision your company has made when facing uncertainty. Compare the expected cost and benefits of the decision. Offer advice on how to proceed. Compute the profit consequences of the advice

Answer 1

Ans.

Decision: Capital investment in a new project, and decision on the equity, debt component
The profits of company or project is affected by the business risk and by financial risk. Both of these factors affect the uncertainty of the cash flows of the company or project.
The business risk of a company or project is the risk related to the uncertainty of revenues, referred to as sales risk, and to operating risk, which is the risk attributed to the company’s operating cost structure. Sales risk is affected by the demand of the product, the seasonality of the revenues. Operating risk is depending on the cost structure of the project higher the fixed cost higher the operating risk.
For e.g. if the investment required in a project is $ 1 mln and the cash flow expected from the project are $0.5 m for next 3 years. The project seems viable because the cash flow are more then the investment however the company has the uncertainty of the cash flow not realizing. Also if the company commits higher fixed cost in terms of rent or salaries and not able to sale the product there may even be loss.
In this case company should keep the fixed cost low and ensure the borrowing is funded at very low cost.  
In the given example the profit will be $0.5 million if estimates are right.