Proper Risk Analysis in Capital Investment
Capital Investment Risk Analysis
How can executives and advisors make the best investment decisions for their institutions/clients? Is there a method of risk analysis to help risk management professionals make wise acquisitions, launch new products, modernize the plant, or avoid overcapacity?
In short, yes. Mathematical formulas that predict a single rate of return or ‘best estimate’ are simply not enough when it comes to risk management & analysis. Processing data and specific combinations of variables such as cash flow, return on investment, and risk analysis are also useful to help estimate the odds for each potential outcome. Risk management professionals can examine such acquired data to more accurately rate the chances of substantial gain in their investment strategy.
Out of all the decisions that investment advisors and institutional decision makers must make, there is not one more challenging than making the choice among alternative capital investment opportunities. This decision is daunting– not because of the problem of projecting return on investment under any specific criteria, but in the assumptions and the potential impact on the institution.
With every assumption, there is often a high degree of uncertainty; and, when taken together, the combined uncertainties can multiply into a total uncertainty. This is where the risk management element takes the stage, and it is in the risk analysis efforts that institutions struggle. There is a way to help decision makers sharpen their key capital investment decisions by providing a realistic measurement of the risks involved. Armed with these tools and analysis capabilities…and doing a thorough risk analysis at each possible level of return, decision makers or advisors are then in a position to more accurately measure alternative courses of action for every possible event.
An evaluation of a capital investment project must begin with the general idea that the productivity of the capital is measured by the rate of return expected over a pre-determined period of time. Following the common knowledge that a dollar received next year is worth less to institutions than a dollar in hand today, expenditures three years off are therefore less costly than expenditures of similar cost two years from now. So realistically, the rate of return cannot be calculated until