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"What If" Analyses in Investment Decision Making

Author(s): Katarína Belanová

Journal: Financial Assets and Investing
ISSN 1804-5081

Volume: 3;
Issue: 3;
Start page: 5;
Date: 2012;
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Keywords: forecasting risk | net present value | discounted cash flow valuation | scenario analysis | sensitivity analysis | simulation analysis

In general, each project`s value is estimated using a discounted cash flow (DCF) valuation, and the opportunity with the highest value, as measured by the resultant net present value (NPV) will be selected. The problem with such NPV estimates is that they depend on projected future cash flows. If there are errors in those projections, then estimated net present values can be misleading (a forecasting risk). Basic approach to evaluating cash flow and NPV estimates involves asking “what – if” questions. Accordingly, the paper discusses some organized ways of going about a what – if analysis. Its goal in doing so is to assess the degree of forecasting risk and to identify those elements that are the most critical to the success or failure of an investment. However, as we show in examples, as well as in the practical study, though what – if analysis really allows us to obtain the certain idea of degree of forecasting risk, it does not tell us what to do about the possible errors.
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