Forecasting risk is defined as the possibility or probability that a company dec
ID: 2805592 • Letter: F
Question
Forecasting risk is defined as the possibility or probability that a company decision will be bad due to errors in the projected cash flow. Managing forecasting or estimation risk is critical to financial health of the company. One of the key components of forecasting is to understand the components of the investment that leads to a positive NPV. Depending on the project the components could change. A new product will have a high forecasting risk due to the uncertainty of the success of product. A new product launch can result in sales that exceed expectations or fall below expectations. Exceeding expectation is fine but falling below will result in the capital project failing. What are some of the forecasting risk in other types of projects? What are the inputs to NPV that could cause the project to miss the forecast, resulting in a negative NPV after the project is completed?
Explanation / Answer
Forecasting risks: -
1. Installation of a new plant - Wrong revenue and costs projections migh lead to wrong decisions.
2. Installation of new machine - Wrong productivity forecasting, worng demand forecasting might lead to wrong NPV.
Other inputs to NPV which might cause the project to miss the forecast are: -
1. Wrong revenue projections
2. Wrong cost projections
3. Poorly calculated cost of capital
4. Wrong tax rates taken
5. Wrong method of depreciation of assets taken.
6. Wrong estimation of working capital requirements