Financial and Project Risk Management
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Questions and Answers

What is a crucial step in achieving financial closure for a project?

  • Limiting contractor involvement
  • Choosing a reliable consultant
  • Mobilizing resources effectively (correct)
  • Conducting market research

Which factor is essential to mitigate project construction risk?

  • Minimizing budget allocations
  • Engaging a skilled contractor (correct)
  • Focusing solely on cost reduction
  • Avoiding legal contracts

What type of risk is primarily associated with changes in government legislation affecting business?

  • Political Risk (correct)
  • Environmental Risk
  • Market Risk
  • Financial Risk

How can environmental risks impacting a project be assessed?

<p>Through a thorough environmental study (C)</p> Signup and view all the answers

What is a common challenge faced when financial closure is not achieved?

<p>Implementation becomes difficult (B)</p> Signup and view all the answers

What is the best approach to minimize market risk after project commercialization?

<p>Conducting a comprehensive market study (A)</p> Signup and view all the answers

Which risk involves potential fluctuations in currency rates impacting business costs?

<p>Exchange Risk (A)</p> Signup and view all the answers

What does force majeure refer to in the context of project risks?

<p>Natural disasters beyond control (C)</p> Signup and view all the answers

What does PEST analysis primarily focus on?

<p>External environmental factors (B)</p> Signup and view all the answers

In Porter's Five Forces, which factor relates to the ability of suppliers to affect pricing and quality?

<p>Bargaining power of suppliers (A)</p> Signup and view all the answers

What is the main difference between accounting profit and cash flow in capital investment assessment?

<p>Cash flow accounts for actual cash transactions, while accounting profit can include theoretical revenue. (B)</p> Signup and view all the answers

How does assessing investment project risks benefit an organization?

<p>It enhances predictive capabilities and long-term planning. (B)</p> Signup and view all the answers

What does suitable resource utilization imply in the context of project management?

<p>Efficiently aligning resources with project goals. (B)</p> Signup and view all the answers

What potential risk can arise when subcontracting part of a project?

<p>Loss of control over quality and deadlines. (B)</p> Signup and view all the answers

Which of the following describes a challenge during the financial closure phase of a project?

<p>Ensuring cash flow is aligned with project milestones. (B)</p> Signup and view all the answers

Which of the following methods can be used to assess environmental risks in a project?

<p>PEST analysis and Porter's Five Forces. (C)</p> Signup and view all the answers

Why are cash flows considered to be a better measure of economic viability than accounting profit?

<p>Cash flows reflect actual cash movements, providing a clearer picture of financial health. (C)</p> Signup and view all the answers

What should be done with depreciation when calculating relevant cash flows for investment projects?

<p>Depreciation should be added back to profit after tax. (D)</p> Signup and view all the answers

How should net changes in working capital related to major investments be treated?

<p>They should be included as part of relevant cash flows. (D)</p> Signup and view all the answers

Which of the following statements regarding overhead in capital projects is correct?

<p>The impact of capital projects on overhead should be assessed for relevance. (C)</p> Signup and view all the answers

How should financing costs for a capital project be considered?

<p>They should be included within the discount rate. (D)</p> Signup and view all the answers

What role do sunk costs play in the evaluation of new investment projects?

<p>Sunk costs should be ignored since they are already incurred. (A)</p> Signup and view all the answers

What is the significance of assessing environmental risks in investment projects?

<p>Ignoring environmental risks can lead to long-term financial liabilities. (C)</p> Signup and view all the answers

Which of the following best describes the relationship between investment project risks and financial closure challenges?

<p>High project risks can complicate and delay financial closure. (C)</p> Signup and view all the answers

Flashcards

Financial Closure

Financial closure is the process of securing the necessary funding for a project to begin. It's crucial for large-scale investments.

Project Construction Risk

Risks that arise due to technical challenges during project construction. Experienced contractors and well-defined contracts can mitigate these risks.

Political Risk

Risks associated with changes in the political environment of the host country, which can affect the project's profitability and goals.

Market Risk

Risks related to market demand and pricing for the project's products or services after commercialization.

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Policy Risk

Risks stemming from changes in government policies, such as taxation, investment limits, and import tariffs.

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Exchange Risk

Risks arising from fluctuations in exchange rates, impacting import/export costs and foreign currency repayments.

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Environmental Risk

Risks associated with environmental impacts of the project, including regulations and potential litigation.

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Force Majeure

Unforeseeable events beyond anyone's control, such as natural disasters, that can disrupt projects.

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Why Cash Flow Matters

Cash flow is a measure of a business's actual cash generated and spent, unlike accounting profit which includes non-cash items like depreciation.

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Depreciation in Cash Flow

Depreciation is added back to profit after tax when calculating cash flows, as it's a non-cash expense.

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Working Capital in Cash Flow

Increases in working capital, often required for new projects, are considered when calculating cash flows.

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Overhead in Cash Flow

The impact of capital projects on overhead costs is carefully assessed to determine the relevant cash flow implications.

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Financing Cost in Cash Flow

Financing costs are best included in the discount rate when calculating cash flows, rather than as a separate expense.

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Sunk Cost in Cash Flow

Sunk costs are ignored when calculating cash flows because they are already incurred and cannot be recovered.

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PEST Analysis

A framework for analyzing the external environment of a business, focusing on political, social, economic, and technological factors.

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Porter's Five Forces

A framework for analyzing the competitive landscape of an industry, considering potential new entrants, supplier and buyer power, rivalry among existing players, and the threat of substitutes.

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Accounting Profit

A method of assessing profitability based on revenues and expenses recorded in accounting, without considering the timing of cash flows.

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Cash Flow Analysis

A method of assessing investment proposals that considers the actual cash generated and spent, factoring in the timing of cash flows through discounting techniques.

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Financial Closure Risk

Risks involved in securing the necessary funds for a project to commence.

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Project Construction Risk

Risks associated with the technical aspects of constructing a project, including engineering, procurement, and construction.

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Political Risk

Risks arising from adverse political actions, such as changes in policies or regulations, that can affect project profitability.

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Market Risk

Risks stemming from uncertainties in the market for the project's products or services.

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Policy Risk

Risks related to changes in government policies that can affect a company's operations, such as tax rates and investment regulations.

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Exchange Risk

Risks arising from fluctuations in exchange rates, which can affect a company's profitability, especially for international businesses.

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Environmental Risk

Risks associated with environmental impacts, regulations, and potential legal challenges related to a project.

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Force Majeure Risk

Unexpected events beyond anyone's control, such as natural disasters, that can disrupt project operations.

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Study Notes

Financial Closure Risk

  • Once a decision is made to proceed with a project, resources need to be mobilized for investment.
  • Achieving financial closure is crucial for project implementation, especially for large investments.

Project Construction Risk

  • Technical knowledge problems can be solved by collaboration with experienced EPC contractors.
  • Contract terms should include provisions for liquidated damages in case of delays.
  • Ethical and safety standards need to be imposed on contractors.

Political Risk

  • Political decisions in the host country can negatively affect multinational profits and goals.
  • Adverse political action can range from detrimental to financial, such as laws restricting capital movement.

Market Risk

  • After commercialization, a project might find that its products lack a market or have lower demand or selling price than anticipated.
  • Engaging a good firm for market studies can minimize this risk.

Policy Risk

  • Tax policies and incentive schemes are subject to change with government changes.
  • Policies on FDI limits, permitted sectors for private companies, and import tariffs also change.
  • Sensitivity analyses should be conducted for every project to assess potential policy impacts.

Exchange Risk

  • Fluctuations in exchange rates can negatively impact businesses, affecting import/export costs or foreign currency loan repayments.

Environmental Risk

  • The role of environmental considerations in commercial decisions and litigation is increasing.
  • Companies should thoroughly study environmental risks inherent to their projects.

Force Majeure (Superior force or Act of GOD)

  • Unexpected events beyond any party's control, such as earthquakes or cyclones, can disrupt projects.

Why Cash Flows are a Better Measure of Economic Viability

  • Cash flow reflects the actual cash generated and spent by a business, unlike accounting profit which includes non-cash items like depreciation.

Identifying and Calculating Relevant Cash Flows for Investment Projects

  • Depreciation: Depreciation is added back to profit after tax to arrive at cash flows.
  • Working capital: Increases in working capital, often required for new production facilities, should be considered in calculating cash flows.
  • Overhead: The impact of capital projects on overhead costs needs to be assessed to determine relevance.
  • Financing cost: Financing costs are best accounted for within the discount rate.
  • Sunk cost: Sunk costs are ignored as they are already incurred.

Environmental Analysis - PEST Analysis

  • Political: Factors such as government stability, policies, and regulations.
  • Social: Factors such as demographics, cultural trends, and consumer preferences.
  • Economic: Factors such as economic growth, inflation, and interest rates.
  • Technological: Factors such as technological advancements and innovation.

Environmental Analysis - Porter's Five Forces

  • Potential new entrants: Barriers to entry and the threat of new competitors.
  • Bargaining power of suppliers: The influence of suppliers on pricing and availability.
  • Bargaining power of buyers: The influence of customers on pricing and product specifications.
  • Competitive rivalry: The intensity of competition among existing players.
  • Threat of substitutes: The availability of alternative products or services.

Alternatives in Assessing Capital Investment Proposals

  • Accounting profit: Assesses profitability based on revenues and expenses recorded in accounting.
  • Cash flow: Considers the actual cash generated and spent, incorporating the timing of cash flows through discounting techniques.

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Description

Explore the various risks associated with financial closure, project construction, political influences, market fluctuations, and policy changes that can affect project implementation. This quiz covers essential concepts and strategies for mitigating these risks in large investment projects.

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