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    CHPT 12-1 2019 PDF

    Uploaded by

    Octavio Herrera

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    © All Rights Reserved
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    CHPT 12-1 2019 PDF

    Uploaded by

    Octavio Herrera
    32 views9 pages

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    Chpt 12-1 2019.pdf

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    32 views9 pages

    CHPT 12-1 2019 PDF

    Uploaded by

    Octavio Herrera

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    You are on page 1of 9

    Methods of Describing Project Risk

    Chapter Opening Story

    • Denver International
    Airport Baggage Handling

    What types of uncertainty was in this project?


    How could those uncertainties be analyzed?

    2
    Sources of Uncertainty

    • Sales Revenue – Will anyone really buy this? How much?


    • Operational and Maintenance Costs – What if this
    equipment isn’t reliable?
    • Project Life – What if a new technology comes along that
    is better and this becomes obsolete?
    • Initial Capital Cost – Should we automate our process or
    make it manual and labor intensive? Seattle Boring Machine
    • Future Costs (Inflation of Commodities) -What will Oil cost
    in 10 years?
    • Terminal/Salvage Value – Can this be sold off later?
    • Tax rates and laws – How long will it take to get FDA
    Regulatory approval?
    • ?? – What if our competitors come out with something
    bigger and better
    Comparison of Certainty and Uncertainty

    Certainty
    Uncertainty
    • Find the NPV at a given • Do a good job on “Best Guess”
    MARR and compare or:
    • Use risk adjusted MARR
    • Find the IRR based on
    projected cash flows and • Use Sensitivity Analysis to define
    compare to the given MARR the consequences of errors in
    estimation
    • All based on given cash • “How much can this be Off and
    flows and given project life still make the same decision?”
    – How do you get them and
    • Give your results, the “Is this
    how sure are you that reasonable?” analysis after a good
    they are right? nights sleep

    • Run your results by others for their


    perspective
    Methods of Describing Project Risk

    • Scenario Analysis: a procedure of comparing


    a “base case” to one or more additional
    scenarios, such as best and worst cases, to
    identify the extreme and most likely project
    outcomes.
    • Expected Value Analysis: a procedure of
    combining the output different expectations
    by weighted average
    • Sensitivity Analysis: a procedure of
    identifying the project variables which, when
    varied, have the greatest effect on project
    acceptability.

    Contemporary Engineering Economics, 6th


    edition, © 2015
    5
    I. Scenario Analysis
    • Scenario analysis is a process of analyzing
    possible future outcomes by considering
    alternative possible events (scenarios). The
    analysis is designed to allow improved decision-
    making by allowing more complete
    consideration of outcomes and their
    implications.

    Cases: Best Case (Optimistic)


    Most Likely
    Worst Case (Pessimistic)

    Contemporary Engineering Economics, 6th


    edition, © 2015
    6
    Reclaim Period Overflow of Reclaim Water and add to
    Water Softeners

    Optimistic

    Most Likely

    Pessimistic
    Reclaim from City Water
    Degasifier Make-Up
    60,000 GPD 11,000 GPD
    Water Capital Cost
    Softeners $42,500
    71,000 GPD

    BP&S Boilers
    35,000 GPD 36,000 GPD
    Reclaim Water Case Analysis

    Capital Cost $(42,500)


    Savings - Optimistic $32,101 Expected Value (PV) Optimistic $57,885.32
    Savings - Most Likely $16,050 Expected Value (PV)Most Likely $7,691.09
    Savings - Pessimistic $6,420 Expected Value (PV)Pessimistic ($22,423.56)
    MARR 18%
    Project Life 5 Years

    Overflow Reclaim Analysis


    $50,000.00 Optimistic
    $45,000.00
    $40,000.00
    $35,000.00 Most Likely
    $30,000.00
    $25,000.00
    $20,000.00
    $15,000.00
    $10,000.00 Pessimistic
    $5,000.00
    $-
    Year 1 Year 2 Year 3
    II. Expected Value

    Expected Value -- Long-run average observable if a project


    or activity is repeated many times

    Result is a point estimate based on anticipated outcomes


    and estimated probabilities
    m
    E ( X ) =  X i P( X i )
    i =1

    Where: Xi = value of variable X for i = 1, …, m different values


    P(Xi) = probability that a specific value of X will occur

    In all probability statements, the sum is: When E(X) < 0, e.g., E(PW) = $-2550, a
    cash outflow is expected; the project is
    not expected to return the MARR used

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