Ekonomika Teknik: Uncertainty Analysis

EKONOMIKA TEKNIK
Uncertainty Analysis
Estimates in Economic
Analysis
• Engineering economic analysis is used to evaluate
projects with long term consequences when the time value
of money matters.
• Estimated future consequences are not precise and the
actual values might different.
• If actual costs and benefits are different from the
estimates, an undesirable alternative may be selected.
• This is because the variability of future consequences
is concealed by assuming that the best estimates will
actually occur.
2 Ekonomika Teknik
Example-Choosing the best
estimates
Two alternatives are being considered. The best estimates for
the various consequences are as follows :
A B
Cost $1000 $2000
Net annual benefit $150 $250
Useful life, in years $10 $10
End-of-useful-life salvage value $100 $400
If interest is 3.5%, which alternative has the better net present

worth (NPW)? What then happens If the actual salvage value for
B were $300 instead of $400?
3 Ekonomika Teknik
A Range of Estimates
• It is more realistic to describe parameters with a
range of possible values, rather than a single
value.
• A range could include :
• optimistic estimate
• most likely estimate
• pessimistic estimate
4 Ekonomika Teknik
Example-Justifying estimates
A firm is considering an investment. The firm’s most experienced
project analyst has estimated the values for the useful life and salvage
value.
Optimistic Most likely Pessimistic

Cost $950 $1000 $1150
Net annual benefit $210 $200 $175
Useful life, in years 12 10 8
Salvage value $100 $0 $0
Compute the rate of return for each estimate. If a 10% before tax
minimum attractive rate of return is required, is the investment justified
under all three estimates?
5 Ekonomika Teknik
Mean Value
• Range of scenarios is useful (optimistic, most likely and
pessimistic).
• However, if there are more than a few uncertain variables it is

unlikely that all will prove to be optimistic (best case) or most likely
or pessimistic (worst case).
• This can be addressed by using average or mean values for each

parameter using this developed equation :
6 Ekonomika Teknik
Example-Calculating Mean
Value
A firm is considering an investment. The firm’s most experienced
project analyst has estimated the values for the useful life and salvage
value.
Optimistic Most likely Pessimistic

Cost $950 $1000 $1150
Net annual benefit $210 $200 $175
Useful life, in years 12 10 8
Salvage value $100 $0 $0
Compute the resulting mean rate of return!
7 Ekonomika Teknik
Probability and Expected
Value
• Probabilities are defined so that the sum of probabilities for
all possible outcomes is 1 or 100%.
• Equations below can be used to check that probabilities are

valid. If the probabilities for all but one outcome are known.
8 Ekonomika Teknik
Example-Calculating
Probability Distribution (1)
What are the probability distribution for the annual

benefit and life for the following project? The annual
benefit’s most likely value is $8000 with a probability
of 60%. There is a 30% probability that it will be
$5000 and the highest value that is likely is $10,000.
A life of 6 years is twice as likely as a life of 9 years.
9 Ekonomika Teknik
Example-Calculating
Probability Distribution (2)
Still related to the previous example, the project

described above has a first cost of $25,000. The firm
uses an interest rate of 10%. Assume that the
probability distributions for annual benefit and life are
unrelated or statistically independent. Calculate the
probability distribution for the PW
10 Ekonomika Teknik
Expected Value
• For any probability distribution we can compute the expected value
(EV) or arithmetic average (mean).
• To calculated the EV, each outcome is weighted by its probability,

and the results are summed.
• The equation :
Expected value = OutcomeA x P(A) + OutcomeB x P(B)+…..
11 Ekonomika Teknik
Example-Calculating Expected
Value
(1). The first cost of the project in Example 10-5 is

$25,000. Use the expected values for annual
benefits and life to estimate the present worth. Use
an interest 10%.
(2). Use the probability distribution function of the

PW that was derived in example to calculate the EV
(PW). Does this indicated an attractive project?
12 Ekonomika Teknik
Risk versus Returns (1)
Risk can be thought of as chance of getting an outcome other than the
expected value.
Common measure of risk :

• Probability of a loss
• Standard deviation
Standard deviation is defined as the square root of the variance.

This term is defined as the weighted average of the squared
difference between the outcomes of the random variable X and its
mean. Thus the larger the difference between then mean and the
values, the larger are the standard deviation and the variance.
13 Ekonomika Teknik
Risk versus Returns (2)
Other forms of the equation :
14 Ekonomika Teknik
Example-Calculating Standard
Deviation
(1) What are the
expected values
for each
alternative
(2) What decision is
recommended?
(3) Calculate the
standard
deviations for
insuring and not
insuring.
(4) What can you
derived from the
situations?
15 Ekonomika Teknik
Risk versus Return (3)
• A graph of risk versus return is one way to
consider these items together.
• Risk measured by standard deviation is place on
the x axis, and return measured by expected
value is placed on the y axis.
16 Ekonomika Teknik
Example-Analyzing Risk
versus Return Graph
Project IRR Standard A large firm is discontinuing and
Deviation older product, so some facilities are
1 13.1% 6.5% becoming available for other uses.
The following table summarizes
2 12.0 3.9 eight new projects that would use
the facilities. Considering expected
3 7.5 1.5
return and risk, which projects are
4 6.5 3.5 good candidates? The firm believes
it can earn 4% on a risk free
5 9.4 8.0 investment in government
6 16.3 10.0 securities.
7 15.1 7.0
8 15.3 9.4
F 4.0 0.0
17 Ekonomika Teknik
Reference
• Newnan, Donald G; Eschenbach, Ted G; Lavelle, Jerome P. 2004.
Engineering Economic Analysis. 9th Edition. Oxford University Press, New
York.
• Pujawan, I Nyoman. Ekonomi Teknik. 2009. Guna Widya.Surabaya,
• Park, Chan S. 1997. Contemporary Engineering Economics. 2nd Edition.

Addison-Wesley.
• Sharma, Kal Renganathan. 2015. An Introduction to Engineering

Economics. Cognella Academic Publishing. San Diego
18 Ekonomika Teknik

Ekonomika Teknik: Uncertainty Analysis

Uploaded by

Copyright:

Available Formats

Ekonomika Teknik: Uncertainty Analysis

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ekonomika Teknik: Uncertainty Analysis

Uploaded by

Copyright:

Available Formats

EKONOMIKA TEKNIK

If interest is 3.5%, which alternative has the better net present

Optimistic Most likely Pessimistic

• However, if there are more than a few uncertain variables it is

• This can be addressed by using average or mean values for each

Optimistic Most likely Pessimistic

Compute the resulting mean rate of return!

• Equations below can be used to check that probabilities are

What are the probability distribution for the annual

Still related to the previous example, the project

• To calculated the EV, each outcome is weighted by its probability,

Expected value = OutcomeA x P(A) + OutcomeB x P(B)+…..

(1). The first cost of the project in Example 10-5 is

(2). Use the probability distribution function of the

Common measure of risk :

Standard deviation is defined as the square root of the variance.

Other forms of the equation :

• Pujawan, I Nyoman. Ekonomi Teknik. 2009. Guna Widya.Surabaya,

• Park, Chan S. 1997. Contemporary Engineering Economics. 2nd Edition.

• Sharma, Kal Renganathan. 2015. An Introduction to Engineering

You might also like