ETHIOPIAN CIVIL SERVICE UNIVERSTY

INSTITUTE OF LEADERSHIP AND GOVERNANCE

DEPARTMENT OF PROJECT LEADERSHIP AND MANAGEMENT (SECTION 2)
COURSE TITLE: PROJECT RISK AND DECISION ANALYSIS (PLMT 521)

Project Risk and Decision Analysis: Group Assignment

SECTION 2 - GROUP 4 MEMBERS ID NO

1. Ochan Ochala ECSU 2202839
2. Semeneh Amare ECSU 2202865
3. Sewunet Ayele ECSU 2202699
4. Solomon Bardimo ECSU 2202940
5. Tesfaye Kumsa ECSU 2202954
6. Tigist Belay ECSU 2202726

Submitted to: Girma Tegene

(Associate prof.)

June/2023 G.C.
Addis Ababa, Ethiopia
1. Mrs. Meseret is considering the possibility of opening a small dress shop. Her options are to
open a small shop, a medium-sized shop, or no shop at all. The market for a dress shop can
be good, average, or bad. The net profit or loss for the medium-sized or small shops for the
various market conditions are given in the following table. Building no shop at all yields no
loss and no gain.

Alternatives Good market ($) Average market ($) Bad market ($)
Small shop 75,000 25,000 -40,000
Medium sized shop 100,000 35,000 -60,000
No shop 0 0 0
Probabilities 0.2 0.5 0.3

Which alternative action do you recommend based on each of the following criterion?
(i) Maximax criterion
(ii) Maximin criterion,
(iii) Hurwicz criterion (with α = 0.7)
(iv) EMV criteria (if the probabilities for these three possibilities are .2 for a good
market, .5 for an average market, and .3 for a bad market.)
(v) Min-Max regret table
(vi)The equal likelihood (or Laplace) criterion
Answer
 According to Maximax criterion
Alternatives Good market Average market Bad market Row Maximum
($) ($) ($)
Small shop 75,000 25,000 -40,000 75,000
Medium 100,000 35,000 -60,000 100,000 is column of
sized shop maximum
No shop 0 0 0 0

Decision: alternative “medium sized shop” will be chosen.

 According to Maximin criterion

 Alternatives Good market Average market Bad market Row minimum
($) ($) ($)
Small shop 75,000 25,000 -40,000 -40,000
Medium sized shop 100,000 35,000 -60,000 -60,000
No shop 0 0 0 0 *(column maximum)

Decision: alternative “no shop” will be chosen

 According to Hurwitz criterion.

In order to select best decision out of alternative, it is possible to calculate A Hurwicz weighted
average by using following formula: If α= 0.7
H (Ai) = α (column maximum) + (1 -α) (column minimum) for positive-flow payoffs (profits,
income)
Small shop = 0.7(75,000) +0.3(-40,000) = 52,500 - 12,000 = $40,500
Medium sized shop = 0.7(100,000) + 0.3(-60,000) = 70,000-18,000 = $52,000 is the
maximum
No shop is = Zero because any number multiplied by zero results zero

Decision: alternative “medium sized shop” will be chosen because it has the maximum profit
when comparing with others.

 According to EMV criteria

Alternative Good market ($) Average market ($) Bad market ($) EMV
s (0.5)
(0.2) (0.3)

Small shop 75,000 X 0.2 =15,000 25,000X0.5= 12,500 -40,000X0.3= - 12,000 15,500
Medium 100,000X0.2 =20,000 35,000X0.5 = 17,500 -60,000X0.3 = -18,000 19,500
sized shop
No shop 0X0.2 =0 0X0.5 =0 0X0.3 =0 0

EMV (small shop) = 15000+12500-12000= 15500

EMV (medium shop) = 20000+17500-18000= 19500
EMV (no shop) = 0+0+0= 0

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Decision: alternative “medium sized shop” will be chosen because it has the maximum
expected monetary value when associating with others.

 According to Min-Max regret criteria

In order to use this approach, it is necessary to develop an opportunity loss table.
The opportunity loss reflects the difference between each payoff and the best possible payoff in a
column.
It looks like as;
Alternatives Good market ($) Average market ($) Bad market ($)

Small shop 100,000-75,000 = 25,000 35,000-25,000 =10,000 0-(-40,000) = 40,000

Medium sized 100,000-100,000 =0 35,000-35,000 =0 0-(-60,000)= 60,000
shop
No shop 100,000-0=100,000 35,000-0 =35,000 0-0 = 0

Regret table
Alternatives Good market ($) Average market ($) Bad market ($) Maximum loss (row)

Small shop 25,000 10,000 40,000 40,000

*(column minimum)
Medium 0 0 60,000 60,000
sized shop
No shop 100,000 35,000 0 100,000

Decision: alternative “small shop” will be chosen

 According to The equal likelihood (or Laplace) criterion.
In this approach the decision not focus on either high or low payoffs, but should treat all payoffs
(actually, all states of nature), as if they were equally likely.
Alternatives Good market Average market Bad market Row Average
($) ($) ($)
Small shop 75,000 25,000 -40,000 20,000
Medium sized 100,000 35,000 -60,000 25,000* maximum
shop
No shop 0 0 0 0

Decision: alternative “medium sized shop” will be chosen.

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2. Smart Manufacturing Company is planning to reduce its labor costs by automating a critical
task that is currently performed manually. The automation requires the installation of a new
machine. The cost to purchase and install a new machine is $5,000. The installation of
machine can reduce annual labor cost as indicated in the table below. The life of the machine
is 3 years. The salvage value of the machine after 3 years will be zero. The required rate of
return of Smart Manufacturing Company is 12%.
Year I Year II Year III
Cash flow Probability Cash flow Probability Cash flow Probability
600 0.3 1500 0.1 700 0.5
1000 0.5 800 0.6 500 0.2
800 0.2 600 0.3 900 0.3

Compute net present value (NPV) of the expected labor cost saving of this investment project.
In order to calculate the NPV the EV and the PV should be calculated. Let’s calculate them;
Answer
Expected value (EV)
Year I Year II Year III
Cash Probability EV=CF*P Cash Probability EV= CF*P Cash Probability EV=CF*P
flow flow flow
600 0.3 180 1500 0.1 150 700 0.5 350
1000 0.5 500 800 0.6 480 500 0.2 100
800 0.2 160 600 0.3 180 900 0.3 270
EV = 840 EV = 810 EV = 720

Present value (PV)

Year Expected net cash flow (ENCF) Discount rate (DR) PV= ENCF*DR
0 - 5000 1 -5000*1 = -5000
1 840 0.893 840*0.89 =750.12
2 810 0.797 810*0.797 = 645.57
3 720 0.712 720*0.712 = 512.64

Finally Net present value (NPV)

NPV = ∑ pv0+pv1+pv2+pv3
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 = -5000 + 750.12 + 645.57 + 512.64 =1905.81-5000 = -3090.67g
3. The management of Fine Electronics Company is considering purchasing an equipment to be
attached with the main manufacturing machine. The equipment will cost $6,000 and will
increase annual cash inflow by $2,200. The useful life of the equipment is 6 years. After 6
years, it will have no salvage value. The management wants a 20% return on all investments.

Required: Using traditional (deterministic) approach,

1. Compute net present value (NPV) of this investment project.
2. Should the equipment be purchased according to NPV analysis?

Answer
i. Compute net present value (NPV) of this investment project.
Given:
Cash out flow = $6000
Cash inflow =$2,200
Discount rate =20% or 0.2
Time period =6 consecutive year
Required:
NPV additionally PV
Where, NPV =Net present value and PV = Present value
Solution:
NPV =pv0+pv1+pv2----pv6
Assume that in the deterministic or traditional approach the cash flow is known with certainty
and not subject to any variability or risk. So it did not needs the adjustment of the cash flow to
reflect the risk and use of different discount rate to calculate the NPV.

NPV=∑Pv0+pv1+pv2+pv3+Pv4+Pv5+pv6
CF 0 CF 1 CF 2 −−−Cfn
NPV =∑ + + ± .
( 1+ r ) 0 ( 1+r ) 1 (1+r )2 ( 1+ r ) tn
PV0 = -$ 6,000 because any number the powered by zero is equivalent to 1 and any number
divided by one is a number itself.

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 2,200 2,200 2,200
PV year1 = = = =1,833.33
( 1+ 0.2 ) 1 (1.2)1 1.2
2,200 2,200 2,200
PV year2 = = = =1,527.777
( 1+ 0.2 ) 2 ( 1.2 ) 2 1.44
2,200 2,200 2,200
PV year3 = = = =1,273.148
( 1+ 0.2 ) 3 ( 1.2 ) 3 1.728
2,200 2,200 2,200
PV year4 = = = =1,061.26
( 1=0.2 ) 4 ( 1.2 ) 4 2.073
2,200 2,200 2,200
PV year5 = = = =884.24
( 1+ 0.2 ) 5 ( 1.2 ) 5 2.488
2,200 2,200 2,200
PV year6 = = = =738.25
( 1+ 0.2 ) 6 ( 1.2 ) 6 2.98
NPV = ∑ - 6,000+1,833.33+1,527.777+1,273.148+1,061.26+884.24+738.25
= ∑ - 6,000+7,318.005
NPV =1,318.005

ii. Should the equipment be purchased according to NPV analysis?

Yes! It is possible to purchase the equipment because the Net present value of investment is
positive and the investment exceeds the required rate of return, and therefore may considered
worthwhile investment.

4. Assume that a company wants to buy equipment having a useful life of 5 years with an initial
investment of 15,000 dollar. It is estimated that the equipment will increase annual net cash
flow as given below:

a) Calculate the present value of expected cash flow using 14% cost of capital.
b) Should the equipment be purchased?
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Answer
a) Calculate the present value of expected cash flow using 14% cost of capital.
To calculate the present value of the expected cash flow, we need to find the expected cash flow
for each year and discount it to its present value using the formula:
PV = CF /(1+r )n
Where:
CF = cash flow
r = required rate of return (cost of capital)
n = number of years
Using the expected annual cash flows and probabilities given, we can calculate the expected
cash. This cash flow is the same for all years this means year1, year2, year3, year4, and year5
Expected cash flow is = $4,500 x 0.2 + $6,000 x 0.3 + $8,500 x 0.3 + $10,000 x 0.2 = $7,250

To calculate the present value of the expected cash flow, we need to discount each cash flow
using the required rate of return of 14% and the number of years from now until each cash flow
is received. Using the formula above, we get:
PV Year 1 = 7,250 / (1 + 0.14) ^1 = $6,359.65
PV Year 2 = 7,250 / (1 + 0.14) ^2 = $5,581
PV Year 3 = 7,250 / (1 + 0.14) ^3 = $4892
PV Year 4 = 7,250 / (1 + 0.14) ^4 = $4,292.5
PV Year 5 = 7,250 / (1 + 0.14) ^5 = $3,766.2
The present value of the expected cash flow is the sum of all the present values of the expected
cash flows:
PV of expected cash flow = $ 6,359.65+ $ 5,581+ $4892+ $4,292.5 + $3,766.2= $24,891.4
Therefore, using a 14% cost of capital, the present value of the expected cash flow for the
equipment investment is $24,891.4. This means that if the cost of the equipment is less than or
equal to this amount, the investment would be considered acceptable based on the expected cash
flow.

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b) Should the equipment be purchased?
Yes!! It should be purchased, because the cost of the equipment is less than the present value
of the expected cash flow for the equipment investment. $24891.4 > 15,000.

5. A company is evaluating investment options in terms of risks and generated the following
statistics for ranking the options.

You, an expert of risk analyst, are requested to prioritize the options from the best to the worst.
Using the appropriate risk evaluation tool, rank the investment options

Answer
To prioritize the options from the best to the worst we should have to calculate the coefficient of
variance because the each investment option has different standard deviation and expected
return. So
standard deviation
Coefficient variance =
expected return
13,000
CV of option1 = = 0.765 1st highly risky
17,000
7,000
CV of option2 = = 0.226 5th and less risky (best investment)
31,000
9,000
CV of option3 = =0.29 4th risky investment
31,000
23,000
CV of option4 = = 0.46 3rd risky investment
50,000
88,000
CV of option5 = = 0.5 2nd risky investment
176,000
Assume: The highest coefficient variance indicates the greatest risk level, and the lowest
coefficient variance indicates the lower the risk level.
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In general prioritizing according to the risk level 0.765 > 0.5 > 0.46 > 0.29 > 0.226
Investment rank best to worst Investment 2, Investment 3, Investment 4, Investment 5 and Investment 1
6. Risk management is very essential especially in dynamic environment for every organization,
be business, non-business, religious and any other type in order for the organization to be
competitive and successful. In this regard, briefly describe the specific benefits of risk
management to an organization. Also state how SWOT analysis helps in identifying factors
affecting organizational.

Answer
Risk management is indeed essential for every organization, as it helps to identify potential
risks and opportunities, and to develop strategies to mitigate or exploit them. The specific
benefits of risk management to an organization include:
Minimizing losses: By identifying and mitigating potential risks, an organization can reduce
the likelihood and impact of losses, which can help to protect the
organization's assets and reputation.
Improving decision-making: A risk management approach provides decision-makers with a
more complete understanding of the risks and opportunities facing
the organization, which can help to inform strategic decisions and
resource allocation.
Enhancing resilience: Risk management helps organizations to build resilience by
identifying potential risks and developing strategies to mitigate or
adapt to them. This can help organizations to weather unexpected
challenges and emerge stronger.
Improving stakeholder confidence: By demonstrating a commitment to risk management,
organizations can enhance stakeholder confidence and trust, which
can help to attract and retain customers, investors, and employees.
SWOT analysis is a tool that can help organizations to identify and analyze the internal and
external factors that may affect their risks. SWOT stands for Strengths, Weaknesses,
Opportunities, and Threats, and the analysis involves identifying and assessing each of these
factors. By identifying strengths and opportunities, organizations can develop strategies to
exploit them, while by identifying weaknesses and threats, organizations can develop
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 strategies to mitigate or adapt to them. By considering these factors in the context of risk
management, organizations can develop a more comprehensive understanding of their risks
and opportunities, and develop strategies to address them. For example, a SWOT analysis
might identify a weakness in the organization's supply chain as a potential risk factor, which
could then inform the development of a risk management strategy to address the weakness
and mitigate the risk. Overall, SWOT analysis provides a valuable framework for
organizations to identify and analyze the factors that may affect their risks, and to develop
effective risk management strategies accordingly.

7. A director of the Ethiopian Women Lawyers Association (EWLA) wants to increase

capacity to provide free legal advice but must decide whether to do so by hiring another full-
time lawyer or by using part-time lawyers. The table below shows the expected costs of the
two options for three possible demand levels:

Which alternative action do you recommend based on each of the following criterion?
(i) Maximax criterion
(ii) Maximin criterion,
(iii) Hurwicz criterion (with α = 0.7)
(iv) EMV criteria (if the probabilities for these three possibilities are .2 for a good
market, .5 for an average market, and .3 for a bad market.)
(v) Min-Max regret table
(vi)The equal likelihood (or Laplace) criterion
Answer
i. Maximax criterion
Alternative State of nature
Low demand Medium demand High demand Minimum rows
Hire full time $300 $500 $700 $300

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 Hire part-time 0 $350 $,1000 $0 column
minimum

:
Decision alternative “hire part-time” will be recommended.

ii. Maximin criterion

Alternative State of nature
Low demand Medium demand High demand Maximum rows
Hire full time $300 $500 $700 $700 column
minimum
Hire part-time 0 $350 $,1000 $1,000

:
Decision alternative “hire full-time” will be recommended

iii. Hurwitz criterion (with α = 0.7)

The decision alternative will be recommended by, Hurwitz criterion for above state of
nature’s According to the following formula.
H (Ai) = α (column minimum) + (1 -α) (column maximum) for negative-flow payoffs
(costs, losses)
Hire full time H (Ai) = 0.7X300+0.3X700 =210+210 =$420
Hire part-time H (Ai) = 0.7X0+0.3X1000 = 0+300 =$300

:
Decision alternative “hire part-time” will be recommended

iv. EMV criteria

Alternative State of nature
Low Medium High Expected pay
demand(0.2) demand( 0.5) demand(0.3) off
Hire full time $300X0.2 = 60 $500x0.5 = 250 $700X0.3 = 210 $520
Hire part-time 0X0.2 = 0 $350X0.5 =175 $,1000X.3 =300 $475

:
Decision alternative “hire part-time” will be recommended

v. Min-Max regret table

Regret table
Alternative State of nature

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 Low demand Medium demand High demand
Hire full time $300- 0 =300 $500-350 = 150 $700-700 =0
Hire part-time 0-0 = 0 $350-350 =0 $,1000- 700 = 300

Alternative State of nature

Low demand Medium demand High demand Minimum loss
Hire full time $300 $150 $0 $300
Hire part-time $0 $0 $300 $300

Decision : Both alternatives have equal outcome. According to minimax regret criterion, we will be
indifferent. But based on the variation of the states of nature of each alternative, we recommend hiring
full time.
vi. The equal likelihood (or Laplace) criterion
Alternative State of nature
Low demand Medium demand High demand Row average
Hire full time $300 $500 $700 $500
Hire part-time 0 $350 $,1000 $450

Average (full time) = ($300+$500+$700)/3= $500

Average (full time) = (0+$350+$1000)/3= $450

:
Decision alternative “hire part-time” will be recommended

8. Good decision-making opportunities (Step 1) and good alternatives are more important
than the actual evaluation methods. Why? Explain using garbage in garbage out
concept.
Answer
The statement that good decision-making opportunities and good alternatives are more
important than the actual evaluation methods is true, and can be explained using the concept
of "garbage in, garbage out."

This concept refers to the fact that the quality of the output of a process is only as good as the
quality of the input. In other words, if the input is flawed or incomplete, the output will also
be flawed or incomplete, regardless of the quality of the process used to generate it.

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 In the context of decision-making, this means that the quality of the alternatives being
considered and the opportunities being evaluated are more important than the evaluation
methods used to assess them. If the alternatives being considered are flawed or incomplete,
or if the opportunities being evaluated are not well understood, then any evaluation method
used to assess them will also be flawed or incomplete, and may lead to poor decisions.

For example, if a company is considering two potential investments, but one of the
investments is poorly understood and has incomplete information, then any evaluation
method used to assess the investment will be flawed, and may lead the company to make a
poor investment decision. Conversely, if both investments are well understood and have
complete information, then even a simple evaluation method may be sufficient to make an
informed investment decision.

Therefore, it is essential to ensure that good decision-making opportunities and good

alternatives are identified and evaluated thoroughly before any evaluation method is used.
This will help to ensure that the output of the evaluation process is reliable and useful, rather
than simply reflecting the flaws or incompleteness of the input. In other words, if the input is
garbage, the output will also be garbage, no matter how sophisticated or advanced the
evaluation method used.

Generally, good decision-making opportunities and good alternatives are more important than
the actual evaluation methods because they provide the foundation for making informed
decisions. Without a solid foundation, any evaluation method used will be unreliable and may
lead to poor decisions. So, it is essential to focus on identifying and evaluating good alternatives
and opportunities before any evaluation method is used to avoid the "garbage in, garbage out"
problem and to ensure that the output of the decision-making process is reliable and useful.

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