myz-vgb.ru A Business Encyclopedia

Hillier Model

Definition: According to the Hillier model, the risk associated with the project can be assessed through the standard deviation of expected cash flows. In other words, determining the viability of the project through calculating the deviations in the cash flows from the mean of expected cash flows.

Thus, Hillier model asserts that the computation of standard deviations of several ranges of cash flows enables a firm to determine the uncertainty involved in the future projects.

This model was proposed by F.S. Hillier and according to him, the expected Net Present Value and the standard deviation of the Net present value of the project can be determined through analytical derivations. Under this model, there are two cases of analysis:

  • When there is no correlation among the cash flows
  • When there is a perfect correlation among the cash flows.

When the cash flows of different years are uncorrelated, then the cash flow in the year “t” is independent of the cash flow in the year “t-n”. Whereas, if the cash flows of different years are perfectly correlated, then the cash flows in each period will be alike.

The formula to compute the Net present Value and the standard deviation under both the cases is given below:

Uncorrelated Cash Flows

NPV = nt=1 [Ct / (1+i)t] – I

∂ (NPV) = nt=1 [∂t2/ (1+i)2t]1/2

Correlated Cash Flows

NPV = nt=1 [Ct / (1+i)t] – I

∂(NPV) = nt=1[ ∂t/ (1+t)t]

Where, Ct = Expected cash flow of the year “t”
t= standard deviation of cash flow for the year “t”
i = risk free rate
I = initial investment

2 Comments

    1. Megha M Reply

      We normally use the risk-free rate to discount the future cash flows principally to quantify the project risk, evaluate it and then decide on a risk-adjusted discount rate. The risk-adjusted rate is used to further discount the cash flows in case the profile of the investment project is highly risky.
      The same formula, as mentioned in the content, will be used to compute the value of NPV, just in the place of a risk-free rate the value of risk-adjusted discount rate will be used. The risk-adjusted discount rate is the sum of the risk-free rate and the risk premium. Symbolically,

      Risk-adjusted discount rate = risk-free rate + risk premium

      The risk premium can be calculated by using the CAPM method:

      Risk premium = β (rm – rf)
      rm= market risk
      rf=risk free rate
      β= risk of the project

      The amount of risk premium depends on the investor’s level of risk aversion and his perception of the risk associated with the investment. when the investment risk is high, a high risk-adjusted discount rate is used and vice-versa.
      Effect: There is an inverse relationship between the value of NPV and the risk adjusted discount rate, which means, if the adjusted rate increases the value of NPV decreases,thereby making the project a riskier one.

Leave a Reply

Your email address will not be published. Required fields are marked *

Shares

Related pages


indifference schedulediscuss scientific management theorystraddle exampledeterminants of individual demandwhat is the meaning of stepping stonefinal balloon paymentmeaning of retrenchmentirr definationneo classicism definitionmoral suasiondefine segmentingtypes of isoquantsconcept of sampling distributionfixed asset turnover examplegovernment bills definitionequity theory and motivationdefine questionerdefine the elasticity of demanddescribe the process of classical conditioningblake mouton managerial gridtypes of oligopoly marketlockbox account definitionstrongly agree likert scalefixed order quantity inventory modeloperant conditioning marketingemployment provident fund organisationdefine debenturedefine wholesalingcharacteristics oligopoly market structurequota sampling methodhenri fayol leadership theorylaissez faire what does it meanhygiene motivation factorswhat is the meaning of ethnocentricdefine the term oligopolyhindi meaning of contingencyexample of geocentriccardinal utility theory of consumer behaviourdefinition ethnocentriccauses of seasonal unemploymentwhat is meant by micro financecorrelation coeffdefine encirclementspearman coefficient correlationcoperate definitiondemand pull inflation definitionequity theory definitionstock turnover ratio formula examplegeographical segmentation definitionapprenticeship training definitionadams equity theory of motivationmichael porter five forces modeltakeovers definitiontransactional analysis in business communicationfiedler leadershipfiedler contingency theory of leadershipdefine debenturenpv sensitivity analysisreinforcement theory bf skinnerexplain indifference curveadvantages and disadvantages of sales promotiondivestment meaning in hindiweber bureaucratic modelmeaning of semi variable costwhat is ppf schemeexplain liquidationtypes of conflict management pptemployees provident fund organization indiafinance lease operating leasesimplex method application in businesszero payout policyorientation meaning in urdudefine operant conditioning psychologyunemployment defcrr ratioarbitrage meaning in financennp at factor costsegmenting consumer marketsinflation definition macroeconomicsfactors of promotion mixneoclassical definition