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Risk Analysis in Capital

Budgeting

M. SADIQUL ISLAM

M. Sadiqul Islam
Risk Analysis in Capital
Budgeting

 To assess the risks in capital budgeting.


 To incorporate risk in capital budgeting
decisions.

M. Sadiqul Islam
Types of Project Risks
1. Stand Alone Risk
2. Corporate Risk or Within-Firm Risk
3. Market Risk (Beta Risk)

M. Sadiqul Islam
Stand Alone Risk
Stand-alone risk is the risk of an independent /
isolated project.
- It is the risk of a single project without considering
the project’s relation with other projects.
- The risk of a single project firm is stand-alone risk.
- It is measured by the variability of project’s
expected returns.

M. Sadiqul Islam
Corporate Risk or Within-Firm Risk
It is the contribution of the project to the total
risk of the firm.
- It is the project’s risk to the corporation,
giving consideration to the fact that a
fraction of project risk is diversified away.

M. Sadiqul Islam
Market Risk (Beta Risk)
It is contribution of the project to the total risk
of a well-diversified investor.
- It is measured by the project’s effect on the
firm’s beta coefficient.

M. Sadiqul Islam
Project Risks
P
Stand Alone Risk

F rP,F rP,M M
Risk of Firm’s Market Risk
Other Assets

P   P 
 P , F   rP , F  P ,M   rP ,M
 F   M 
Within  Firm Risk Market Risk of Project
M. Sadiqul Islam
Techniques of Measuring
Stand Alone Risk

1. Sensitivity Analysis
2. Scenario Analysis
3. Monte Carlo Simulation
4. Decision Tree Analysis

M. Sadiqul Islam
Sensitivity Analysis
Sensitivity analysis is a technique that
indicates exactly how much NPV or IRR
will change in response to a given change in
an input variable, other things remaining the
same.

M. Sadiqul Islam
Sensitivity Analysis

NPV Sensitivity Analysis


60,000 Sales
50,000 Price
Units Sold
30,000

WACC
10,000
0 Fixed Cost
-10,000
Variable Cost

-30% -15% 0%
M. Sadiqul Islam
+15% +30%
Sensitivity Analysis
Change NPV at Different Deviations from Base Case ($)
from Base
Case Sales Variable Units Fixed WACC
Price Cost Sold Cost

-30% (40,223) 59,996 (14,832) 20,226 14,855


-15% (15,707) 36,225 276 15,485 12,286
0 10,109 10,109 10,109 10,109 10,109
15% 38,209 (11,105) 26,457 6,455 8,856
30% 59,338 (40,221) 37,364 1,267 6,965
Range 99,561 100,217 52,196 21,493 21,820
M. Sadiqul Islam
Sensitivity Analysis
- Steeper the slope, the more sensitive the
NPV is to a change in the variable.
- When we compare two projects, the one
with steeper sensitivity lines is more risky.

M. Sadiqul Islam
Scenario Analysis
Stand alone risk depends on:
1. Sensitivity of its NPV to changes in key
variables;
2. Range of likely values of these variables as
reflected in their probability distribution.

Highly sensitive inputs may be controlled by


making contracts.
M. Sadiqul Islam
Scenario Analysis
Scenario analysis is technique that considers
both the sensitivity of NPV to changes in
key variables and the range of likely
variable values to determine the impact on
project’s NPV under different possible
scenarios.

M. Sadiqul Islam
Scenario Analysis
Scenario Probability of Sales Volume Sales NPV
Outcome Units Price ($’000)

Worst Case 0.25 15,000 1,700 (10,079)

Most Likely 0.50 25,000 2,200 12,075


Case

Best Case 0.25 35,000 2,700 41,752

M. Sadiqul Islam
Scenario Analysis
Expected NPV = 0.25(-10,079) + 0.5(12,075)
+ 0.25(41,752)
= $13,956
 NPV  [0.25(10,079  13,956) 2  0.5(12,075  13,956) 2  0.25(41,752  13,956) 2 ]
 18,421
 NPV 18,421
CV NPV    1.3
E ( NPV ) 13,956

M. Sadiqul Islam
Scenario Analysis

- CV can be of one project can be compared with


that of another project.
- CV can also be compared with company’s average
assets.

Limitations:
It considers few discrete outcomes for the project,
although there are infinite number of possibilities.

M. Sadiqul Islam
Monte Carlo Simulation
Monte Carlo simulation is technique that ties
together sensitivities and input variable
probability distributions to determine
possible outcomes of a project.

M. Sadiqul Islam
Monte Carlo Simulation
Steps:
a. Specify the probability distribution of each cash
flow variables (such as sales price, unit sales).
b. Choose at random a value for each uncertain
variable based on its probability distribution.
c. Determine the net cash flow and estimate NPV.
d. Repeat the procedure for many times (say 1000
times) and make a probability distribution of NPV.
Estimate the expected value, S.D. and CV of NPV.

M. Sadiqul Islam
Monte Carlo Simulation
Example: Expected NPV = $12,078
S.D. of NPV = 10,686
CV of NPV = 0.88

M. Sadiqul Islam
Monte Carlo Simulation
Problems:
- Difficult to specify each uncertain variable’s
probability distribution and the correlation
among distributions.
- No clear-cut decision may not emerge.
- Applicable only to stand alone risk ignores
the effect of diversification.

M. Sadiqul Islam
Decision Tree Analysis
Managers may be more concerned with reducing the
risk (rather than measuring it).

 When a project requires capital outlays over


several years, managers may evaluate the project
using decision tree.

 The Expected NPV, S.D. and C.V of one project


can be compared with those of another project.

M. Sadiqul Islam
Decision Tree Analysis
 Additional considerations:
 The effect of abandonment
- The project may have other managerial
options.

M. Sadiqul Islam
Decision Tree Analysis
Joint Prob.
=0 t=1 t=2 t=3 t=4 t=5 t=6 Prob. NPV NPV

10,000 10,000 10,000 10,000 0.144 15,250 2,196


0.3
(10,000) 0.4 4,000 4,000 4,000 4,000 0.192 436 84
0.6
0.3
(1,000) (2,000) (2,000) (2,000) (2,000) 0.144 (14,379) (2,071)
0.8 0.4
(500) STOP 0.320 (1,397) (447)
0.2
STOP 0.200 (500) (100)
1.0 (338)
Discount Rate = 11.5%

0.3 0.144 (10,883) (1,567)


(2,000) STOP

Expected NPV = 166


M. Sadiqul Islam
The Impact of Abandonment
When the project continues to make losses, it
is better to abandon the project.
- Possibilities of abandonment may increase
the expected NPV.

M. Sadiqul Islam
The Impact of Abandonment

Additional considerations concerning abandonment:


 Managers can reduce the risk by abandoning the
project. They can structure the decision process to
include several decision points.
Once production begins, if the firm can shut down its
operations, it could dramatically reduce the risk.

M. Sadiqul Islam
The Impact of Abandonment
 The cost of abandonment is generally reduced if
the firm has alternative uses for the project’s
assets.

All inputs to a capital budgeting decision change


over time. Firms must review both their capital
expenditure plans and their on-going projects
(e.g., the demand for product has fallen
dramatically).

M. Sadiqul Islam
Within-Firm Risk or Corporate Risk
A project’s corporate risk is the contribution of the
project to the firm/s overall total risk.
- It is the impact of the project on the variability of
the firm’s consolidated cash flows.
- Corporate risk is a function of (P , rP,F).
- High (P) and high (rP,F) add to high corporate risk.
If uncorrelated or negatively correlated, the project
would have low corporate risk.

M. Sadiqul Islam
Within-Firm Risk or Corporate Risk
A corporate risk beta of 1.0 is just as risky as firm’s
other assets.

It is difficult to estimate the return distribution of a


single project.

- Often the corporate risk is estimated subjectively.


- If the project is in company’s same line of business,
it has high corporate risk.

M. Sadiqul Islam
Market Risk
Market risk is the contribution of the project
to the risk of a well-diversified portfolio of
stocks.
It is the most relevant type of risk to equity
investors.

M. Sadiqul Islam
Market Risk
Security Market Line of CAPM:
K S  K RF  (K M - K RF )  i
 8%  (13% - 8%)1.8  17%
WACC  K a  Wd K d (1 - T)  WS K S
 0.5(10%)(1 - 0.4)  0.5(17%)
 11.5%
M. Sadiqul Islam
Market Risk
Investors will be willing to invest in the
company’s average risk project if the
company can earn 11.5% or more.

M. Sadiqul Islam
Methods of Estimating Project Beta
Two methods of estimating project beta:
1. Pure Play Method
2. Accounting Beta Method

M. Sadiqul Islam
Pure Play Method
Under this method, the beta of one or more
non-integrated single project firm in the
same line of business is taken as a proxy.
- It is an easier to find a precise estimate of
beta.
- But sometimes, it may be difficult to find a
proxy firm.

M. Sadiqul Islam
Accounting Beta Method
In this method, beta is estimated by regressing
company’s basic earning power
(EBIT/Total Assets) against average
earning power for a large sample of stocks.

It can be estimated for all types of companies


or for divisions.

M. Sadiqul Islam
Accounting Beta Method:

Most studies indicate that accounting betas


are reasonable proxies of market betas.
- The correlation between accounting beta and
market beta is generally between 0.5 and
0.6.

It provides a rough approximation for market


beta, market risk and the cost of capital.

M. Sadiqul Islam
Risk Adjusted Discount Rate Vs.
Certainty Equivalents
Although other methods give an idea about the risk
of projects, it is difficult to incorporate differential
risk into capital budgeting decisions.

Two traditional methods to deal with project risk:


a. Certainty Equivalents
b. Risk Adjusted Discount Rate

M. Sadiqul Islam
Certainty Equivalent Approach
Expected cash flows are adjusted to reflect
project risk.
- Risky cash flows are scaled down.
- Riskier the cash flows, lower the certainty
equivalents.
Certainty equivalents are discounted at the
risk free rate.

M. Sadiqul Islam
Risk Adjusted Discount Rate
Additional risk premium is added for more risky
projects.

Average risk projects are discounted at the firm’s


WACC.
- Above-average risky projects are discounted at a
higher rate.
- Below average risky projects are discounted at a
lower rate.

M. Sadiqul Islam
Risk Adjusted Discount Rate
 Compounding the risk premium over time implies
that the risk is increasing over time.
- Imposes a severe burden of long-term projects.

 Risk adjusted discount rate is frequently used,


because -
- It is easier.
- If the risk is perceived to be an increasing function
of time, it is a valid approach.

M. Sadiqul Islam
Risk Adjusted Discount Rate
 However, some projects are risky in the
short run, but less risky in the long run,
(e.g., water project, gas project, public
utility etc).
For these projects, risk adjusted discount rate
is not appropriate.

M. Sadiqul Islam
Country Risk Assessment
Major methods for country risk assessments:
1. ICRG Method
2. World CAPM or Multifactor Model (Sharpe-Ross)
3. Segmented / Integrated (Beckaert-Harvey)
4. Baysian (Ibbotson Associates)
5. CAPM with Skewness (Harvey-Siddique)
6. Goldman Integrated Sovereign Yield Spread
7. Goldman Segmented
8. Goldman EHV Hybrid
9. CSFB Volatility ratio
10. CSFB-EHV Hybrid
11. Damodaron Method
M. Sadiqul Islam
Country Risk Assessment
International Country Risk Guide (ICRG) Method:

ICRG Rating system is based on a set of 22


components grouped into 3 major categories of risk:

Political risk - 12 components (& 15 subcomponents)


Financial risk - 5 components
Economic risk - 5 components.

M. Sadiqul Islam
Country Risk Assessment
A. Political Risk:
Assess the political stability of the countries
covered by ICRG on a comparable basis.

M. Sadiqul Islam
Country Risk Assessment
POLITICAL RISK COMPONENTS
Sequence Component Points (max.)
A Government Stability 12
B Socioeconomic Conditions 12
C Investment Profile 12
D Internal Conflict 12
E External Conflict 12
F Corruption 6
G Military in Politics 6
H Religious Tensions 6
I Law and Order 6
J Ethnic Tensions 6
K Democratic Accountability 6
L Bureaucracy Quality 4
Total 100
M. Sadiqul Islam
Country Risk Assessment
Political Risk
Government Stability – 12 Points
This is an assessment both of the government’s ability
to carry out its declared program(s), and its ability to
stay in office.
Max. Score
• Government Unity 4.00 points
• Legislative Strength 4.00 points
• Popular Support 4.00 points
4 points for very low risk, 0 points for very high risk.

M. Sadiqul Islam
Country Risk Assessment
Political Risk
Socioeconomic conditions – 12 Points
Assess the socioeconomic pressures at work in
society that could constrain government action or
fuel social dissatisfaction.
Max. Score
•Unemployment 4.00 points
•Consumer Confidence 4.00 points
•Poverty 4.00 points
4 points for very low risk, 0 points for very high risk.

M. Sadiqul Islam
Country Risk Assessment
Political Risk
Investment Profile – 12 Points
Assess factors affecting the risk to investment that are
not covered by other political, economic and financial
risk components.
Max. Score
Contract Viability/Expropriation 4.00 points
Profits Repatriation 4.00 points
Payment Delays 4.00 points
4 points for very low risk, 0 points for very high risk.

M. Sadiqul Islam
Country Risk Assessment
Political Risk
Internal Conflict – 12 Points
Assess political violence in the country and its actual
or potential impact on governance.

Max. Score
Civil War 4.00 points
Terrorism/Political Violence 4.00 points
Civil Disorder 4.00 points
4 points for very low risk, 0 points for very high risk.
M. Sadiqul Islam
Country Risk Assessment
Political Risk
External Conflict – 12 Points
Assess both of the risk to the incumbent government
from foreign action, ranging from non-violent external
pressure to violent external pressure (diplomatic pressures,
withholding of aid, trade restrictions, territorial disputes, sanctions, etc.
Max. Score
War 4.00 points
Cross-Border Conflict 4.00 points
Foreign Pressures 4.00 points
4 points for very low risk, 0 points for very high risk.
M. Sadiqul Islam
Country Risk Assessment
Political Risk
Corruption – 6 Points
Assess corruption within the political system.
Corruption is a threat to foreign investment.
- Distorts the economic and financial environment.
- Reduces the efficiency of government and business
by enabling people to assume positions of power
through patronage rather than ability.
- introduces an inherent instability into the political
process.
6 points for very low risk, 0 points for very high risk.
M. Sadiqul Islam
Country Risk Assessment
Political Risk
Military in Politics – 6 Points
Military involvement in politics is a diminution of
democratic accountability.
The military might become involved in government
because of an actual or created internal or external
threat. This may distort government policy in order to
meet this threat.

6 points for very low risk, 0 points for very high risk.
M. Sadiqul Islam
Country Risk Assessment
Political Risk
Religious Tensions – 6 Points
Religious tensions may stem from the domination of
society and/or governance by a single religious group
that seeks to replace civil law.

6 points for very low risk, 0 points for very high risk.

M. Sadiqul Islam
Country Risk Assessment
Political Risk
Law and Order – 6 Points
Law and Order are assessed separately.
The Law sub-component is an assessment of the
strength and impartiality of the legal system.
The Order sub-component is an assessment of popular
observance of the law.
Max. Score
Law (including judicial system) 3.00 points
Order (including crime rate) 3.00 points
3 points for very low risk, 0 points for very high risk.
M. Sadiqul Islam
Country Risk Assessment
Political Risk
Ethnic Tensions – 6 Points
This component is an assessment of the degree of
tension within a country attributable to racial,
nationality, or language divisions.

6 points for very low risk, 0 points for very high risk.

M. Sadiqul Islam
Country Risk Assessment
Political Risk
Democratic Accountability – 6 Points
This is a measure of how responsive government is to its people,
on the basis that the less responsive it is, the more likely it is that
the government will fall, peacefully in a democratic society, but
possibly violently in a non-democratic one.
Alternating Democracy (Government served not more than 2 successive terms)
Dominated Democracy (Government served more than two successive terms)
De-facto One-Party State (Government served more than two successive terms
and political or electoral system is designed to create domination by one party.)
De jure One-Party state (Constitutionally only one party.)
Autarchy Leadership by a group or single person, without being subject to any
franchise, either through military might or inherited right.
6 points for very low risk, 0 points for very high risk.
M. Sadiqul Islam
Country Risk Assessment
Political Risk
Bureaucracy Quality – 4 Points
The institutional strength and quality of the
bureaucracy is a shock absorber that tends to
minimize revisions of policy when governments
change. Therefore, high points are given to countries
where the bureaucracy has the strength and expertise
to govern without drastic changes in policy or
interruptions in government services.

4 points for very low risk, 0 points for very high risk.
M. Sadiqul Islam
Country Risk Assessment
Political Risk
ASSESSING POLITICAL RISK
Overall, a political risk rating of indicates a; and.
Once again, however, a poor political risk rating can
be compensated for by a better financial and/or
economic risk rating.
0.0% to 49.9% Very High Risk
50.0% to 59.9% High Risk
60.0% to 69.9% Moderate Risk
70.0% to 79.9% Low Risk
80.0% or more Very Low Risk
M. Sadiqul Islam
Economic Risk Assessment
THE ECONOMIC RISK RATING
The overall aim of the Economic Risk Rating is to
provide a means of assessing a country’s current
economic strengths and weaknesses.

GDP Per Head


Real GDP Growth
Annual Inflation Rate
Balance of Payment as a % of GDP
Current Account as a % of GDP
M. Sadiqul Islam
Economic Risk Assessment

GDP Per Head


The estimated GDP per head for a given year,
converted into US dollars at the average
exchange rate for that year, is expressed as a
percentage of the average of the estimated total
GDP of all the countries covered by ICRG.

M. Sadiqul Islam
Economic Risk Assessment
GDP Per Head
% of average Points
250.0 plus 5.0
200.0 to 249.9 4.5
150.0 to 199.9 4.0
100.0 to 149.9 3.5
75.0 to 99.9 3.0
50.0 to 74.9 2.5
40.0 to 49.9 2.0
30.0 to 39.9 1.5
20.0 to 29.9 1.0
10.0 to 19.9 0.5
Up to 9.9 M. Sadiqul Islam 0.0
Economic Risk Assessment

Real GDP Growth

The annual change in the estimated GDP, at


constant 1990 prices, of a given country is
expressed as a percentage increase or decrease.

M. Sadiqul Islam
Economic Risk Assessment
Real GDP Growth
Change (%) Points Change (%) Points
6.0 plus 10.0 -0.5 to -0.9 4.5
5.0 to 5.9 9.5 -1.0 to -1.4 4.0
4.0 to 4.9 9.0 -1.5 to -1.9 3.5
3.0 to 3.9 8.5 -2.0 to -2.4 3.0
2.5 to 2.9 8.0 -2.5 to -2.9 2.5
2.0 to 2.4 7.5 -3.0 to -3.4 2.0
1.5 to 1.9 7.0 -3.5 to -3.9 1.5
1.0 to 1.4 6.5 -4.0 to -4.9 1.0
0.5 to 0.9 6.0 -5.0 to -5.9 0.5
0.0 to 0.4 5.5 -6.0 plus 0.0
-0.1 to -0.4 5.0

M. Sadiqul Islam
Economic Risk Assessment

Annual Inflation Rate


The estimated annual inflation rate (the
unweighted average of the Consumer
Price Index) is calculated as a percentage
change

M. Sadiqul Islam
Economic Risk Assessment
Annual Inflation Rate
Change (%) Points Change (%) Points
0.0 to 1.9 10.0 19.0 to 21.9 5.0
2.0 to 2.9 9.5 22.0 to 24.9 4.5
3.0 to 3.9 9.0 25.0 to 30.9 4.0
4.0 to 5.9 8.5 31.0 to 40.9 3.5
6.0 to 7.9 8.0 41.0 to 50.9 3.0
8.0 to 9.9 7.5 51.0 to 65.9 2.5
10.0 to 11.9 7.0 66.0 to 80.9 2.0
12.0 to 13.9 6.5 81.0 to 95.9 1.5
14.0 to 15.9 6.0 96.0 to 110.9 1.0
16.0 to 18.9 5.5 111.0 to 129.9 0.5
130.0 plus 0.0

M. Sadiqul Islam
Economic Risk Assessment

Budget Balance as a Percentage of GDP


The estimated general government budget balance
(excluding grants) for a given year in the national
currency is expressed as a percentage of the
estimated GDP for that year in the national
currency.

M. Sadiqul Islam
Economic Risk Assessment

Budget Balance as a Percentage of GDP


% GDP Points % GDP Points
4.0 plus 10.0 -5.0 to -5.9 5.0
3.0 to 3.9 9.5 -6.0 to -6.9 4.5
2.0 to 2.9 9.0 -7.0 to -7.9 4.0
1.0 to 1.9 8.5 -8.0 to -8.9 3.5
0.0 to 0.9 8.0 -9.0 to -9.9 3.0
-0.1 to -0.9 7.5 -10.0 to -11.9 2.5
-1.0 to -1.9 7.0 -12.0 to -14.9 2.0
-2.0 to -2.9 6.5 -15.0 to -19.9 1.5
-3.0 to -3.9 6.0 -20.0 to -24.9 1.0
-4.0 to -4.9 5.5 -25.0 to -29.9 0.5
-30.0 plus 0.0

M. Sadiqul Islam
Economic Risk Assessment
Current Account as a Percentage of GDP
The estimated balance on the current account of
the balance of payments for a given year,
converted into US dollars at the average exchange
rate for that year, is expressed as a percentage of
the estimated GDP of the country concerned,
converted into US dollars at the average rate of
exchange for the period covered.

M. Sadiqul Islam
Economic Risk Assessment
Current Account Balance as a % GDP
% GDP Points % GDP Points
10.0 plus 15.0 -16.0 to -16.9 7.0
8.0 to 9.9 14.5 -17.0 to -17.9 6.5
6.0 to 7.9 14.0 -18.0 to -18.9 6.0
4.0 to 5.9 13.5 -19.0 to -19.9 5.5
2.0 to 3.9 13.0 -20.0 to -20.9 5.0
1.0 to 1.9 12.5 -21.0 to -21.9 4.5
0.0 to 0.9 12.0 -22.0 to -22.9 4.0
-0.1 to -0.9 11.5 -23.0 to -23.9 3.5
-1.0 to -1.9 11.0 -24.0 to -24.9 3.0
-2.0 to -3.9 10.5 -25.0 to -26.9 2.5
-4.0 to -5.9 10.0 -27.0 to -29.9 2.0
-6.0 to -7.9 9.5 -30.0 to -32.5 1.5
-8.0 to -9.9 9.0 -32.5 to -34.9 1.0
-10.0 to -11.9 8.5 -35.0 to -39.9 0.5
-12.0 to -13.9 8.0 -40.0 plus 0.0
-14.0 to -15.9 7.5
M. Sadiqul Islam
Economic Risk Assessment
Assessing Economic Risk

40-50 points Very Low Risk


35-39.9 points Low Risk
30-34.9 points Moderate Risk
25-29.9 points High Risk
Less than 25 points Very High Risk

M. Sadiqul Islam
Financial Risk Assessment

Assess a country’s ability to pay its official,


commercial, and trade debt obligations.
Factors considered:
1. Foreign Debt as a Percentage of GDP
2. Foreign Debt Service as a % of Exports of Goods and Services
3. Current Account as a % of Exports of Goods and Services
4. Net International Liquidity as Months of Import Cover
5. Exchange Rate Stability

M. Sadiqul Islam
Financial Risk Assessment
Foreign Debt as a Percentage of GDP
Foreign Debt % GDP
Ratio (%) Points Ratio (%) Points
0.0 to 4.9 10.0 60.0 to 69.9 4.5
5.0 to 9.9 9.5 70.0 to 79.9 4.0
10.0 to 14.9 9.0 80.0 to 89.9 3.5
15.0 to 19.9 8.5 90.0 to 99.9 3.0
20 to 24.9 8.0 100.0 to 109.9 2.5
25.0 to 29.9 7.5 110.0 to 119.9 2.0
30.0 to 34.9 7.0 120.0 to 129.9 1.5
35.0 to 39.9 6.5 130.0 to 149.9 1.0
40.0 to 44.9 6.0 150.0 to 199.9 0.5
45.0 to 49.9 5.5 200.0 plus 0.0
50.0 – 59.9 5.0
M. Sadiqul Islam
Financial Risk Assessment
Foreign Debt Service as a Percentage of Exports of Goods and Services
Debt Service % XGS
Ratio (%) Points Ratio (%) Points
0.0 to 4.9 10.0 41.0 to 44.9 5.0
5.0 to 8.9 9.5 45.0 to 48.9 4.5
9.0 to 12.9 9.0 49.0 to 52.9 4.0
13.0 to 16.9 8.5 53.0 to 56.9 3.5
17.0 to 20.9 8.0 57.0 to 60.9 3.0
21.0 to 24.9 7.5 61.0 to 65.9 2.5
25.0 to 28.9 7.0 66.0 to 70.9 2.0
29.0 to 32.9 6.5 71.0 to 75.9 1.5
33.0 to 36.9 6.0 76.0 to 79.9 1.0
37.0 to 40.9 5.5 80.0 to 84.9 0.5
85.0 plus 0.0
M. Sadiqul Islam
Financial Risk Assessment
Current Account as a Percentage of Exports of Goods and Services
Current Account as % XGS
Ratio (%) Points Ratio (%) Points
25.0 plus 15.0 -45.0 - to –49.9 7.5
20.0 to 24.9 14.5 -50.0 to –54.9 7.0
15.0 to 19.9 14.0 -55.0 to –59.9 6.5
10.0 to 14.9 13.5 -60.0 to –64.9 6.0
5.0 to 9.9 13.0 -65.0 to –69.9 5.5
0.0 to 4.9 12.5 -70.0 to –74.9 5.0
-0.1 to –4.9 12.0 -75.0 to –79.9 4.5
-5.0 to –9.9 11.5 -80.0 to –84.9 4.0
-10.0 to -14.9 11.0 -85.0 to –89.9 3.5
-15.0 to –19.9 10.5 -90.0 to –94.9 3.0
-20.0 to –24.9 10.0 -95.0 to –99.9 2.5
-25.0 to –29.9 9.5 -100.0 to –104.9 2.0
-30.0 to –34.9 9.0 -105.0 to –109.9 1.5
-35.0 to –39.9 8.5 -110.0 to –114.9 1.0
-40.0 to –44.9 8.0 -115.0 to –119.9 0.5
Below –120.0
M. Sadiqul Islam
0.0
Financial Risk Assessment
Net International Liquidity as Months of Import Cover
Net Liquidity in Months
Months Points
15 plus 5.0
12.0 to 4.9 4.5
9.0 to 11.9 4.0
6.0 to 8.9 3.5
5.0 to 5.9 3.0
4.0 to 4.9 2.5
3.0 to 3.9 2.0
2.0 to 2.9 1.5
1.0 to 1.9 1.0
0.6 to 0.9 0.5
0.0 to 0.59 0.0
M. Sadiqul Islam
Financial Risk Assessment
Exchange Rate Stability Exchange Rate Stability
Appreciation Change, plus Depreciation Change, minus Points
0.0 to 9.9 -0.1 to –4.9 10.0
10.0 to 14.9 -5.0 to -7.4 9.5
14.5 to 19.9 -7.5 to -9.9 9.0
20.0 to 22.4 -10.0 to -12.4 8.5
22.5 to 24.9 -12.5 to -14.9 8.0
24.9 to 27.4 -15.0 to -17.4 7.5
27.5 to 29.9 -17.5 to -19.9 7.0
30.0 to 34.9 -20.0 to -22.4 6.5
35.0 to 39.9 -22.5 to -24.9 6.0
40.0 to 49.9 -25.0 to -29.9 5.5
50 plus -30.0 to -34.9 5.0
-35.0 to -39.9 4.5
-40.0 to -44.9 4.0
-45.0 to -49.9 3.5
-50.0 to -54.9 3.0
-55.0 to -59.9 2.5
-60.0 to -69.9 2.0
-70.0 to -79.9 1.5
-80.0 to -89.9 1.0
-90.0M.
toSadiqul
-99.9 Islam 0.5
THE COMPOSITE RISK RATING
Composite Political, Financial, and Economic Risk Rating

CPFER (country X) = 0.5 (PR + FR + ER)


where
CPFER = Composite political, financial & economic risk ratings
PR = Total political risk indicators
FR = Total financial risk indicators
ER = Total economic risk indicators

M. Sadiqul Islam
THE COMPOSITE RISK RATING
Composite Political, Financial, and Economic Risk Rating
Very High Risk 00.0 to 49.5 points
High Risk 50.0 to 59.5 points
Moderate Risk 60.0 to 69.5 points
Low risk 70.0 to 79.5 points
Very Low Risk 80.0 to 100 points

M. Sadiqul Islam
M. Sadiqul Islam
Evaluating Projects with No Cash
Inflows
When the revenue cannot be estimated
directly, it is appropriate to focus on
comparative costs.
- NPV of costs should be taken for decision-
making.

M. Sadiqul Islam
M. Sadiqul Islam
M. Sadiqul Islam