RISK MANAGEMENT

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
 INTRODUCTION
What is Risks?

What is Risk Management?

Risk Management Steps

 Plan Risk Management

 Identify Risks

 Analyze Risks

 Plan Risk Responses

 Monitor and Control Risks CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
 WHAT IS
RISK?
RISK APPETITE?
RISK TOLERANCE?
RISK MANAGEMENT?

Risk management can be defined as the identification, assessment, and

prioritization of risks followed by coordinated and economical application of
resources to minimize, monitor, and control the probability and/or impact of
unfortunate events or to maximize the realizations of positive risks
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
RISK MANAGEMENT
Identification of Risks minimize control
monitor
Probability and/or impact of
unfortunate events
RESOURCES
Assessment of Risks
Realization of Opportunities

Prioritization of Risks maximize

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
RISK MANAGEMENT PRINCIPLE
❑Create value
❑Be an integral part of organization’s processes
❑Be a part of decision making processes
❑Be systematic and structured
❑Be transparent
❑Be responsive to change
❑Be capable of continual improvement and enhancement
❑Continually-periodically re-assess
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
RISK MANAGEMENT PROCESS
Plan Risk
Management

Monitor Identify
& RISK Risks
Control
MANAGEMENT
STEPS

Plan Risk Analyze

Response Risks

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
PLAN RISK MANAGEMENT
❑ Specifies the management intent, systems and procedures
required
❑ Provide definitions of various risk related terms, roles and
responsibilities related to risks, tools and templates
❑ In a way it specifies how the next four steps in risk management
are executed

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
IDENTIFY RISKS

❑It is the key step in actual management of risks

❑Identifying potential risks, their root causes and its consequences
❑Group effort- subject matter experts from various groups
❑Common tool – brainstorming
❑No identified risks will be evaluated or criticized
❑Other tools Ishikawa diagram, flow diagram, SWOT analysis
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
ANALYZE RISKS
❑Limited Resources – there for analyze and prioritize risks
❑Some may need Action Plan and few others may require Periodic
Monitoring
❑It is the process of quantifying the risk events
❑Risk analysis – Qualitative or Quantitative
❑Qualitative – Subjective- quick and easy to perform (ex. Probability and
impact matrix)
❑Quantitative is detailed analysis and is not required for all (ex. Expected
monetary value analysis, Monte Carlo analysis, Decision trees.
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
PROBABILITY AND IMPACT MATRIX
Qualitative analysis tool.
Two aspects 1) Probability the risk will happen 2) Potential impact if the risk happens
Risk Score = Probability x Impact
Organization creates guidelines for example
9- Very High – Risk event expected to occur
7- High – Risk event more likely to occur
Low Impact High Impact
5- Probable – Risk may or may not occur High Probability High Probability
3- Low – Less likely to occur
1- Very low – Not expected to occur Low Impact High Impact
Low Probability Low Probability
Risk may impact- cost, schedule, scope, quality
Fig 1- Sample Impact Table
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
RISK RESPONSE
Negative Risk Positive Risk

Avoid Exploit

Mitigate Enhance

Transfer Share

Accept Accept

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
 METHODS OF DESCRIBING PROJECT RISKS
We may analyze project risk by first determining the
uncertainty inherent in a project’s cash flows.
Simple informal judgements to complex economic
and statistical quantities.
1. Sensitivity Analysis
2. Breakeven Analysis
3. Scenario Analysis
4. Probability Techniques – Monte Carlo Simulations and Decision Trees
5. Other approaches of Modelling and Simulations
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
 SENSITIVITY ANALYSIS
❑Get glean a sense of possible outcomes of investment
❑Effect on NPW for variations in the input variables (ex. Revenues, operating costs, salvage
value etc.)
❑How much NPW will change for a given change in input variable.
Results may imply It Begins with
Base Case
▪Some items may have greater influence on final results, Analysis
▪In some cases most significant item may be identified
For example: 1) Sales volume is always critical or
2) Find items that has significant influence – can be subjected to scrutiny (“What-if” analysis).
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
 BREAK-EVEN ANALYSIS (BEA)
❑In sensitivity we asks How serious the effect of lower revenues or higher
costs
❑Sometimes managers may prefer how much sales can decrease below
forecast before the project begins to loose money.
❑BEA is a technique for studying the effect of variations in output on a
firms NPW or other measures.
Here,
❑PW of cash flows as a function of unknown variable ‘x’.
PW of cash inflows = f(x)1; PW of cash outflows = f(x)2
Break-even value (x) implies f(x)1 = f(x)2
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
 SCENARIO ANALYSIS
Sensitivity and Break-even has limitations- Difficult to specify precisely the relationship
between particular variable and NPW.

Interdependencies between variables and its effect on NPW is different.

For example Operating costs constant we may vary unit sales for ease in analysis but
actual behavior?
Scenario analysis is a technique that considers the sensitivity of NPW both to changes
in key variables to the range of likely values.
For example two extreme case ( Worst case scenario
CHAN S. PARK, and
"CONTEMPORARY ENGINEERING Best
ECONOMICS", case
4TH EDITION, scenario)
PEARSON PRENTICE HALL, 2007.
EXAMPLE – FOR BREAK-EVEN ANALYSIS
PW of Cash Inflows = PW of Cash Outflows

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
EXAMPLES

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
 PW (15%) Inflows = (PW of after tax net revenue) + (PW of net salvage value) +
(PW of tax savings for depreciation)

= 30X (P/A, 15%, 5) + 37389 (P/F, 15%, 5) + 7145 (P/F, 15%, 1) + 12245 (P/F,
15%, 2) + 8745 (P/F, 15%, 3) + 6245 (P/F, 15%, 4) + 2230 (P/F, 15%, 5)
= 100.5650X + $44,490

PW (15%) Outflows = (PW of Capital Expenditure) + (PW of after-tax expenses)

= 125,000 + (9X + 6000) (P/A, 15%, 5)

= 30.1694X + $145,113
Now Equate for X,
X = 1,430 units.

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
SCENARIO ANALYSIS

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.
THANK YOU!!!

CHAN S. PARK, "CONTEMPORARY ENGINEERING ECONOMICS", 4TH EDITION, PEARSON PRENTICE HALL, 2007.