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Chapter 10. Managing Risk and Uncertaint... > Tools for Managing Risk and Uncertai...

Tools for Managing Risk and Uncertainty

Successful entrepreneurs also use two financial tools for managing uncertainty: real options and scenario analysis. Real options are the right, but not the obligation, to make a future investment. Scenario analysis is the representation of investments under different assumptions about key factors that influence those investments. You should use these tools to manage uncertainty in your business because their use will help you to make better decisions about your new venture than if you do not use them.

These tools overcome many of the disadvantages of more standard estimates of discounted cash flow based on net present value calculations. Standard net present value calculations do not accommodate uncertainty. Because they rely on point estimates, net present value calculation, do not deal well with a range of probabilities. Thus, any effort to use net present value calculations requires the user to simplify uncertainty by replacing uncertain things with point estimates. As a result, real options and scenario analysis help entrepreneurs to make more accurate decisions under uncertainty.


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