Managing Risk Flashcards
Why is risk important when making investment decisions
The long timescales involved - there is more time for things to go wrong between the decision being made and the completion of the project compared to other business decisions.
The scale of funds involved – most investment projects involve very large amounts of finance. If things go wrong, the impact can be both significant and lasting for a business!
Scenario Analysis Pros
Highlights overall impact of negative and positive changes
It helps identify what may happen (e.g. a major recession)
Supports the assessment of the viability of major projects
Scenario Analysis Cons
It takes a considerable amount of time and resources to identify and achieve consensus on variables, evaluate options and develop different scenarios
Manual scenario analysis processes are costly; this caused Shell to consider shutting down its scenario planning team on several occasions
It’s difficult (even if computerised!) to determine accurately the numerical and financial value of variables, even those known, over time
Sensitivity Analysis Drawbacks
It does not give managers clear decision rules concerning acceptance or rejection of a project - they must rely on their own judgement.
It does not provide any indication of the likelihood that a particular change to an input factor will actually occur.
It is a static form of analysis - only one input is considered at a time, while the rest are held constant (in reality, it is likely that more than one input value will differ from the best estimates provided).
Expected Values Drawwbacks
produces an average figure that may not be capable of occurring
using an average figure can obscure underlying risk associated with the project
