Risk

Question 1

What is expected value ?

Answer 1

The expected value if decisions were to be repeated numerous times (is the average outcome)

Sum of: outcome * estimated probability

Question 2

How do you deal with risk with the expected value?

Answer 2

Choose the HIGHEST expected value

Question 3

What are the different attitudes to risk?

Answer 3

Risk averse
Risk takers
Risk neutral

Question 4

What is the maximin?

Answer 4

Assuming the worst outcome

Maximise the minimum payoff

Question 5

What is the maximax?

Answer 5

Assume the best outcome

Maximise the maximum payoff

Question 6

What is regret?

Answer 6

Assume you haven’t selected the best criteria

Minimise the amount of regret

Question 7

How do you complete a risk decision rules question?

Answer 7

1. Calculate monetary impact
   (MS, XS, SF)
2. Payoff table
   (Decisions along top, outcome along side, for each level work out the MS, XS, SF, CONTRIBUTION)
3. Decision rules
   (Maximin - for each production level choose the minimum, then choose the highest minimum)
   (Maximax - for each production level choose the maximum, then choose highest)

(regret - prepare the regret table, decisions along top, outcomes down side, highest level is 0, then go along and do highest - lowest, for each production level choose highest regret, choose least out of highest)

(expected value - decisions along top, outcome and probability down side, for each do contribution from payoff * probability, total each decision, choose highest EV)

Question 8

What are decision trees?

Answer 8

Diagrams illustrating choices and possible outcomes of a decision

Question 9

What do the illustrations on a decision tree mean?

Answer 9

Square = decision point
Line = option/ alternative
Circle = outcome point

Question 10

How to complete a decision tree question?

Answer 10

1. Clarify the decisions
2. Sketch the tree
   (start with decisions, if choosing products they are first branch, if decision is to launch or not they are the 2 branches)
3. Draw the tree
   (put in outcome and probabilities)
4. Calculate EV at the decision point
   (work back to calculate)
5. Choose highest EV

Question 11

Give advice to the management team using the cost structure as a basis.

Answer 11

Use the monetary impact, how much does it cost the company to undersell, how much does it cost to oversell? Which is financially better?

Be aware of the risk to customer relationship, does under producing harm this?

Be aware of opportunity to increase market share and sell more.