Financial Management : Scenario Analysis

Scenario analysis is the assessment of the possible future results of a situation by exploring the various expected outcomes. Scenario analysis starts with the possible scenarios that are expected to occur. The scenario analysis should include the evaluation of many factors; numerical, visualization and relational. Scenario analysis is used to make decisions based on the expected future occurrences. Despite the helpful nature of the scenario analysis technique, it has some drawbacks, which include; It is a time consuming and expensive technique.

It is time consuming in that all the possible scenarios are evaluated and analyzed so as the future occurrences are well predicted. Analyzing all these scenarios needs the use of a lot of resources. The various future outcomes predicted using the scenarios analysis should not be a total assurance of the future actual happenings. Any business should not rely absolutely on the results of scenario analysis to chart their operations. Scenario analysis is a subjective method if few factors are considered.

This is because it only analyses those scenarios that are likely to occur. Hence to improve on its objectivity when conducting a scenario analysis, one should consider all factors. There is also no uniform identification of the possible future outcomes in a scenario analysis due to the difficulties of using simultaneous trends and counter trends. Simulation Simulation is the “copying” of the actual occurrence, happening or process. It performed by taking the possible expected conditions and subjecting them to a process so as to get the possible outcomes.

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It is used to analyze dangerous missions, space exploration or scenarios where the outcomes are not certain. An example of simulation technique is the Monte Carlo system. Some of the advantages of performing simulation analysis are; It enables the analysis of the behavior of a process without actually going through the actual process. This is especially important for testing new procedures e. g. a new surgical procedure. In most cases, the results of simulation process are almost accurate compared to the actual process.

Hence it is able to present reliable information that can be used for decision-making. Uncertain events are normally explored using simulations analysis. It helps the analyst to get an idea of the possible outcomes in an uncertain environment without actually going through it. Another advantage of simulation analysis is that it is easy to perform and hence it provides an effective analysis of simulations or processes easily. Simulation however, has disadvantages some of which are; The simulation models needs to be built.

The building of these models is usually an expensive undertaking hence small companies may not be able to use simulation. The simulation process itself is very expensive because in a simulation, all the factors are considered and collecting the required data is expensive. Since the simulation process considers all possible outcomes the results produced are in many cases huge. The interpretation of these outcomes is difficult and may take time, which may make the information irrelevant. Question 2 Alesco Financial Inc (AFN) is an investment trust specializing in real estate.

It is a Real Estate Investment Trust (REIT). Sales Increase In AFN Inc. sales include trust preferred securities (TruPS), mortgage backed securities (MBS) and Corporate Loan Obligation (CLO). The increase in sales in this case means the increase in the investment in TruPS, MBS and CLOs. This increase will result in the increase in the amount of interest income received and at the same time increasing the assets of the company. Dividend payout ratio increases Dividend pay out ratio is the rate at which the company pays out dividends from the earnings attributable to stockholders.

Increase in dividend payout ratio means the shareholders receives more dividends. AFN Inc made losses for the year to September, 2007. Dividends are paid out profits made. Any increase in the payment of dividends means increased distribution of Loss. The Company paid a dividend of $0. 31 per share for the first quarter. Therefore, as long as the company made losses, any increase in DPR means the increase in the payment of the loss. Capital intensity ratio increase This is a ratio that measures the amount of revenue that is produced by a given amount of capital invested.

It shows the efficiency of the capital invested in generating sales. Over the last year, the investment by AFN Inc have been increasing and hence the increased incomes from these investments. The interest income from these investments depends on the performance of these investments. The increase in the capital intensity ratio improved incomes due to the efficient utilization of the investment. Reference: L Franz JBM Theo (2003) How to improve scenario analysis as a strategic management tool? Retrieved on 15/11/2007 from http://www. sciencedirect.

com/science? _ob=ArticleURL&_udi=B6V71-4BG44N9-1&_user=10&_coverDate=02%2F28%2F2005&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=5fdc2b87b30d3107f6d85f7e0de16f3e Xiannong M (2002) Advantages and Disadvantages Retrieved on 15/11/2007 from http://www. eg. bucknell. edu/~xmeng/Course/CS6337/Note/master/node3. html CNN (2007) Alesco Financial Inc. Announces Third Quarter 2007 Financial Results Retrieved on 15/11/2007 from http://money. cnn. com/news/newsfeeds/articles/prnewswire/NYM19705112007-1. htm

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