ECONOMICS

Detailed explanation-1: -In capital budgeting, risk is the degree of variability of cash flows. In capital budgeting, risk is generally thought of as the chance that NPV and IRR will provide conflicting recommendations to management. The break even cash inflow is the minimum level of cash inflow necessary for a project to be acceptable.

Detailed explanation-2: -Risk is the probability of damage, loss or threat. Risk in capital budgeting implies that the decision maker knows the probability of cash flows. Therefore, risk in capital budgeting means uncertainty of cash flows.

Detailed explanation-3: -However, in practical terms, risk and uncertainty are used interchangeably. In brief, risk with reference to capital Budgeting, results from the variation between the estimated and actual return. The greater the variability between the two, the riskier is the project. (ii) Certainly equivalent method.

Detailed explanation-4: -Risk in capital budgeting has three levels: the project’s stand-alone risk, its contribution-to-firm risk, and systematic risk. Stand-alone risk measures a project’s potential without factoring in the potential risk that it adds to the company’s assets and other projects.

Detailed explanation-5: -Risk and uncertainty in capital Budgeting: The Capital budgeting is based on Cash flows. These cash flows are estimated cash flows. The estimation on future returns, cash flows, is done on the basis of various assumptions.