Risk Analysis and Assessment Techniques
You can use NPV with the Monte Carlo Method 1. identify the factors that are uncertain (Raw mat costs) 2. Estimate the range and likelihood of the occurrence (raw mat costs likely to be between $20-$40 with 50% change of being $20 and 10% of being $40) 3. Select at randon from the distribution of values for each factor and combine them to generate the NPV 4. Repeat many times to see what results you get
Knowing the shapes of possible NPV distribution helps decision makers assess the expected NPV of competeing projects .................................XX.......|ZZZ ...............................X....X...Z|.......Z .............................X.......XZ |............Z ............................X____Z__|_X________Z_____________ MINUS.............................NEUTRAL.......................POSITIVE
Decision Trees and Risk Analysis Combine the decision tree with the distributions See Hertz Thomas p 543
Other references http://www.mindtools.com/pages/article/newTED_04.htm http://en.wikipedia.org/wiki/Decision_tree
Limitations of Risk Analysis Can be wrongly interpreted as precise Has it been undertaken with attention to detail Models can be overrelaint on the past Difficulty in incorporating soft factors Perceived risk is an individual perception
Risk Indices
Business Envrionment Rick Indicators - BERI or EIU
Limitations of Rick Indices
- Good for macro insignts not micro firm
- Assumes we can make judgements on the future based upon the past
