Scribd
Upload
97 views

Techniques of Risk Analysis

This document discusses techniques for analyzing risk in projects. It describes two broad categories of risk analysis: (1) techniques that consider the standalone risk of a project, and (2) techniques that consider risk in the context of a firm or market. Several standalone risk analysis techniques are then outlined, including sensitivity analysis, scenario analysis, break-even analysis, simulation analysis, and decision tree analysis. An example of simulation analysis and decision tree analysis is also provided to illustrate how each technique is applied.

Uploaded by

Sandeep_Varma_9362
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
97 views

Techniques of Risk Analysis

This document discusses techniques for analyzing risk in projects. It describes two broad categories of risk analysis: (1) techniques that consider the standalone risk of a project, and (2) techniques that consider risk in the context of a firm or market. Several standalone risk analysis techniques are then outlined, including sensitivity analysis, scenario analysis, break-even analysis, simulation analysis, and decision tree analysis. An example of simulation analysis and decision tree analysis is also provided to illustrate how each technique is applied.

Uploaded by

Sandeep_Varma_9362
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 22

Techniques Of Risk Analysis

Risk Analysis
• Risk Analysis and Management is a process
designed to remove or reduce the risks which
threaten the achievement of project objectives.
• Risk can fall into two broad categories
i. techniques that consider the stand alone risk of
a project
ii. techniques that consider the risk of a project in
the context of a firm or in the context of the
market
Sources Of Risk
• Project Specific Risk
• Competitive Risk
• Industry Specific Risk
• Market Risk
• International Risk
• Stand-alone risk measures the dangers
associated with a single facet of a company's
operations or by holding a specific asset. In
portfolio management, standalone risk
measures the undiversified risk of an
individual asset. For a company, standalone
risk allows them to determine a project's risk
as if it were operating as an independent
entity.
Stand Alone Risk

SENSTIVITY ANALYSIS SCENARIO ANALYSIS

BREAK EVEN ANALYSIS HILLIER MODEL

SIMULATION ANALYSIS DECISION TREE ANALYSIS


Sensitivity Analysis

This is also known as a "what if analysis".


Because of the uncertainty of the future, if an
entrepreneur wants to know about the
feasibility of a project in variable quantities,
for example investments or sales change from
the anticipated value, sensitivity analysis can
be a useful method. This is calculated in terms
of NPV, or net present value. 
Scenario Analysis

 In the case of scenario analysis, the focus is on


the deviation of a number of interconnected
variables. It is different from sensitivity
analysis, which usually concentrates on the
change in one particular variable at a specific
point of time. 
Break Even Analysis

The Break Even Analysis allows a company to


determine the minimum production and sales
amounts for a project to avoid losing money.
The lowest possible quantity at which no loss
occurs is called the break-even point. The
break-even point can be delineated both in
financial or accounting terms. 
Hillier Model

 In particular situations, the anticipated NPV


and the standard deviation of NPV can be
incurred with the help of analytical derivation.
This was first realized by F.S. Hillier. There
are situations where correlation between cash
flows is either complete or nonexistent. 
Simulation Analysis
Simulation analysis is utilized for formulating
the probability analysis for a criterion of merit
with the help of random blending of variable
values that carry a relationship with the
selected criterion. 
Decision Tree Analysis
The principal steps of decision tree analysis are
the definition of the decision tree and the
assessment of the alternatives. 
Example: Simulation
• Zenith chemicals is evaluating an investment
project whose net present value has been
modeled as follows
• NPV= - Initial investment

• Risk free rate =10%


• Initial investment=Rs 13000
Annual Cash Flows Project Life
VALUE PROBABILITY
VALUE PROBABILITY
3 .05
1000 .02
4 .10
1500 .03
5 .30
2000 .15
6 .25
2500 .15
7 .15
3000 .30
8 .10
3500 .20
9 .03
4000 .15
10 .02

The firm wants to perform 10 manual runs for the


project.
Annual Cash Flow Project Life
VALUE PROBAB Cumulati Two VALUE PROBAB Cumulati Two
ILITY ve Digit ILITY ve Digit
Probabili Random Probabili Random
ty No. ty No.

1000 .02 0.02 00-01 3 .05 0.05 00-04

1500 .03 0.05 02-04 4 .10 0.15 05-14

2000 .15 0.20 05-19 5 .30 0.45 15-44

2500 .15 0.35 20-34 6 .25 0.70 45-69

3000 .30 0.65 35-64 7 .15 0.85 70-84

3500 .20 0.85 65-84 8 .10 0.95 85-94

4000 .15 1.00 85-99 9 .03 0.98 95-97

10 .02 1.00 98-99


RANDOM NUMBERS
53479 81115 98036 12217 59526

97344 70328 58116 91964 26240

66023 38277 74523 71118 84892

99776 75723 03172 43112 83086

30176 48979 92153 38416 42436

81874 8339 14988 99937 13213

19839 90630 71863 95053 55532

09337 33435 53869 52769 18801

31151 58925 40823 41330 21093

67619 52515 03037 81699 17106


SIMULATION RESULT
ANNUAL CASH FLOW PROJECT LIFE

RUN RANDOM CORRESP RANDOM CORRESPON NET


NUMBER ONDING NUMBER DING VALUE PRESENT
VALUE OF OF PROJECT VALUE(NPV)
ANNUAL LIFE
CASH
FLOW

1 53 3000 97 9 4277
2 66 3500 99 10 8506
3 30 2500 81 7 (829)
4 19 2000 9 4 (7660)
5 31 2500 67 6 (2112)
6 81 3500 70 7 4039
7 38 3000 75 7 1605
8 48 3000 83 7 1605
9 90 4000 33 5 2163
10 58 3000 52 6 66
EXAMPLE: Decision Tree

• The scientist at Spectrum have come up with an


electric moped. The firm is ready for pilot production
and test marketing . This will cost Rs 20 million and
takes six months. Management believes that there is
70% chance that the pilot production and test
marketing will be successful. In case of success
spectrum can build a plant costing Rs 150 million.
The plant will generate an annual cash inflow of Rs
30 million for 20 years if the demand is high or an
annual cash inflow of Rs 20 million if the demand is
low. High demand has a probability of 0.6, low
demand has the probability of 0.4. What is the
optimal course of action using decision tree analysis?
DECISION TREE

C21 High Annual Cash


Demand Flow 30
D21 million
Invest C2
C11 - Rs 150
Success million Annual Cash
D11 C22 Low
D2 Flow 20
2o million Demand
C1 million
0.7 D22 Stop

D1 C12 D3
0.3 Failure
D22
Do nothing
The optimal course of action is determined as
follows:
1) Start at the right hand end of the tree and
calculate the expected monetary value (EMV)
at chance point C2 that comes first as we
proceed leftwards. EMV
(C2)= 0.69[30* PVFIA (20,12%) ]
+0.4[20*PVIFA(20,12%)]
=194.2 million
2) Evaluate the EMV of the decision alternatives
at D2 the last stage decision point
Alternative EMV
D21(Invest Rs 150 million) Rs 44.2 million

D22(Stop) 0

3) Select D21 and truncate D22 as EMV


(D21)>EMV(D22)
4) Calculate the EMV at chance point C1 that
comes next as we roll backwards.
EMV (C1)= 0.7[44.2] + 0.3[0]
= Rs 30.9 million
5) Evaluate the EMV of the decision alternatives
at D1 the first stage decision point

Alternative EMV

D11(carry out pilot production Rs 10.9 million


and market test at a cost
of Rs 20 million)

D12 (do nothing) 0


Based on the proceeding evaluation, we find
that the optimal decision strategy is as
follows:
Choose D11 (carry out pilot production and
market test) at the decision point D1 at wait
for the outcome at the chance point C1. if the
outcome at C1 is C11 (success), invest Rs 150
million, if the outcome at C1 is C12(failure)
stop.

You might also like