Weighted Average Cost Capital Calculation - Essay Example

Describe how uncertainty is calculated into cash flows. . (Gallagher and Andrew, 2008) Describe how uncertainty is calculated into cash flows. Why should two projects with equal cash flows but unequal risks produce different financial results Would you prefer a low-risk, low-return project or a high-risk, high-return project, and when cash flows are created, it is assumed that all cash flow will be exactly like you expected, but in real life, the cash flow is different, for this reason, we calculate uncertainty.

(Johnathan Mun, 2005) One way to calculate uncertainty in cash flows is to use a discount rate that reflects the riskiness of cash flows. How do you choose the risk associated with cash flows By risk we are referring to uncertainties of future cash flows. (Gil Fried, Steven J. Shapiro, Timothy D. DeSchriver, 2007)A certain Discount rate (risk rate) is set that accounts for a percentage of cash flow that might not be there. Therefore, (1-Discount rate) is the proportion that will be there. The formula to calculate the discounted cash flow is as following: Discounted Cash Flow = Nominal Cash Flow * (1-Discount Rate) ^ Number of years now suppose that Ben and Joe expect to have $1000 at the end of 5 years.

Ben feels that the inflation would be high in the coming years so he keeps the discount rate (or risk rate) at 6 percent per annum while Joe keeps the discount rate at 4 percent. Financial results for Ben after 5 years would be $734 while the financial results for Joe would be $815. Therefore, this is how their financial results will differ. (12manage, 2008)All investors prefer less risk to more.