Chapter 12, Problem 1OR

Summary Introduction

To discuss: The way in which Person X (financial analyst) use the scenario analysis to assess the risk for entering into a joint venture in Country A with YF Company.

Introduction:

Scenario analysis is a process of analyzing the possible future events. This analysis helps to determine the effect of what-if questions towards the net present value estimates. At the time when the firm begins to look for an alternative, then they can be able to find the possible project, which would result in a positive net present value (NPV).

Explanation of Solution

The way wherein Person X uses the scenario analysis to assess the risk for entering into a joint venture in Country A with YF Company is as follows:

A 50 percent decrease in share price indicates that the market discounted cash flows at a higher price of the YP Company. As per the reporter views, the C Company has to take into account the risk associated with the gas and oil exploration and even the political risks for undertaking business in the Country A. The Person X has made a scenario analysis by assuming the worst possible consequences related to both risks. This analysis will help the management of the company to recognize the worst probable outcomes. As a result, the management of the company can take suitable steps to reduce the probability of the worst outcomes.