SECTION RISK ANALYSIS
RISK ANALYSIS
Risk introduction
Risk analysis tools
Risk reducing solutions
RISK INTRODUCTION
What is risk ?
Why risk analysis ?
Types of risk
RISK
WHAT IS RISK?
Risk, in traditional terms, is viewed as a
‘negative’. Webster’s dictionary, for instance,
defines risk as “exposing to danger or hazard”.
The Chinese symbols for risk, reproduced below,
give a much better description of risk
The first symbol is the symbol for “danger”,
while the second is the symbol for
“opportunity”, making risk a mix of danger and
opportunity
WHAT IS RISK?
Risk is possibility of difference between actual
outcome and expected outcome as planned.
WHY RISK ANALYSIS ?
Future Certainty is Uncertainty
Project returns are spread over time
Most variables affecting NPV are subject to high
level of uncertainty
Information and data needed for more accurate
forecasts are costly to acquire
Need to reduce the likelihood to undertake a "bad"

Financial risk
Strategic risk
TYPES OF RISK
BUSINESS RISK
Business risk relating product market of project,
includes:

Technological changes
 Materials, Equipments

Product design
 Substitute

Marketing
 Market demand
 Competitor operations
TYPES OF RISK
FINANCIAL RISK
Financial risk relating possible damages in financial
market

Changes in financial variables:

Interest rate

Exchange rate

Prices

Profitability

Sensitivity analysis doesn't represent the probabilities
for each range. Generally high probability of values
close to mean and a small probability of being at the
extremes.
Direction of effects
For most variables, the direction is obvious
A) Revenue increases NPV increases
B) Cost increases NPV decreases
C) Inflation Not so obvious
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One-at-a-time testing is not realistic because of
correlation among variables
A) If Quantity (Q) sold increases, costs will increase
Profits = Q (P - UC)
B) If inflation rate changes, all prices change
C) If exchange rate changes, all tradable goods' prices
and foreign liabilities change.
 One method of dealing with these combined or
correlated effects is scenario analysis
LIMITATIONS OF SENSITIVITY ANALYSIS
SCENARIO ANALYSIS
Scenario analysis recognizes that certain
variables are interrelated. Thus a small number
of variables can be altered in a consistent
manner at the same time.
What is the set of circumstances that are likely
to combine to produce different "cases" or
"scenarios"?
A. Worst case / Pessimistic case
B. Expected case / Best estimate case

Allocate probability distribution, most common distributions being:
Normal distribution, Triangular distribution, Uniform distribution,
Step distribution
4. Identify and define correlated variables

Positive or negative correlation

Strength of correlation
5. Simulation model: does a series of analysis for various
combinations of parameter values
6. Analysis of results

Statistics

Distributions
SENSITIVITY ANALYSIS
$ Risk Variables
Price
Quantity
Revenue (V1 x V2)
Materials
Salaries
Expenses
Operating Cost (V3 + V4 +V5)
Fixed Cost
Total Costs (F2 + V6)
Profit/Loss (F1 - F3)
V1
V2
F1

x
x
Maximum
Minimum
Observations
Minimum Maximum
Variable Value
Probability
0.1
Minimum Maximum
Variable Value
0.3
0.5
0.1
Time
Now
The Single -Value Estimate
Variable Value
Probability
x
x
x
x
x
x
x
x
x
x
Observations