Chapter 9 -Risk and uncertainty Flashcards
What is described below?
There are a number of possible outcomes and the probability of each outcome is known.
Risk
What is described below?
There are a number of possible outcomes but the probability of each outcome is not known.
Uncertainty
What are three strengths of sensitivity analysis?
- Not complicated to understand
- Enables subjective judgement
- Identifies crucial success areas
What are three weaknesses of sensitivity analysis?
- Assumes variables can change independently
- Does not look at probability of variables changing
- Does not point in direction of correct decision
What are 4 main drawbacks of simulation?
- Only obtains more info, does not make decisions
- Models can be complex
- Can cost more to construct than benefit achieved
- May be difficult to formulate
What are 3 advantages of expected values?
- Takes uncertainty into account
- Single number easier for decision making
- Calculations are simple
What are 3 disadvantages of expected values?
- Probabilities are subjective
- EV has little meaning for one off project
- Does not show other possible outcomes
Where do you put the decision variable in a profit/payoff table?
Along the top
What does the Maximax method do?
Maximizes the maximum payoff achievable?
What sort of investors use Maximax rule?
Risk seekers
What does the Maximin method do?
Maximises the minimum payoff achievable
Who is the maximin method good for
Risk averse pessimists who want to minimise losses
What is regret?
The opportunity loss for having made the wrong decision
What does the minimax regret strategy do?
Minimises the maximum regret
How do you calculate the value of perfect information?
Expected profit with information
Less: Expected profit without information
