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Project risk refers to the possibility that the actual outcomes of a project may differ from the expected outcomes due to uncertainty in future events. In the context of capital investment and financing decisions, project risk is concerned with the variability of cash flows generated by an investment project and the likelihood that the project may fail to meet its financial objectives such as profitability, liquidity, or timely completion. Since capital investment decisions usually involve large amounts of funds, long gestation periods, and irreversible commitments, understanding and measuring project risk becomes crucial for financial managers. Project risk arises from various sources such as market demand fluctuations, changes in technology, cost overruns, interest rate variations, inflation, regulatory changes, and managerial inefficiencies. The higher the uncertainty associated with future cash flows, the higher is the project risk, and therefore the more carefully it must be evaluated before acceptance. Measurement of project risk involves the use of both quantitative and qualitative techniques to assess the degree of uncertainty associated with a project’s expected returns. One of the simplest techniques used to measure project risk is sensitivity analysis. Sensitivity analysis examines how sensitive the project’s net present value (NPV), internal rate of return (IRR), or other profitability measures are to changes in key variables such as sales volume, selling price, variable costs, fixed costs, or project life. In this technique, one variable is changed at a time while keeping other variables constant, and the effect on the project’s outcome is observed. If small changes in a variable lead to large changes in NPV or IRR, the project is considered highly sensitive and therefore risky. Sensitivity analysis helps identify critical variables that have the greatest impact on project viability, _______ ________ ______ __________ _______ ______ ________ ________ _____.
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