Investment Appraisal Essay Example | Topics and Well Written Essays - 2500 words

Investment Appraisal - Essay Example However, there are various risks that emanate from the uncertainty encompassing the projected variables. As a result, it is important to identify and understand the nature of uncertainty in the key project variables and have the tools and methodology to identify its risk implications on the projects return to be able to evaluate the project risks. Uncertainty in a project is evident especially in estimating future values of project variable as being certain; by calculating a â€Å"best estimate† based on the available data and use it as an input in the evaluation model: however, a range of other probable outcomes for each project variable is not included in the analysis. The outcome of the project is, therefore, also presented as a certainty with no possible variance or margin of error associated with it. Risk analysis is methodology whereby the uncertainty encompassing the main variables projected in a forecasting model is analyzed in order to estimate the impact of risk on a projected results. It is a technique based on the Monte Carlo simulation by which a mathematical model is subjected to a number of simulation runs, whereby successive scenarios are built up using various input values for the project's key uncertain variables that are selected from multi-value probability distributions. After simulation, the results are collected and analyzed statistically to arrive at a probability distribution of the potential outcomes of the project and to estimate various measures of project risk.