Describes about the Risk Identification and Ranking Risk and Net Present Value Cost Benefit Analysis Risk Profile Analysis Using decision Trees

1. Risk Evaluation
By
P.Shanmugapriya,KEC

2. • Risk Identification and Ranking
• Risk and Net Present Value
• Cost Benefit Analysis
• Risk Profile Analysis
• Using decision Trees

3. • Risk Identification and Ranking
• In any project evaluation we should attempt to identify the risks and quantify their potential effects.
• One common approach to risk analysis is to construct a project risk matrix utilizing a checklist of
possible risks and to classify each risk according to its relative importance and likelihood.
• Note that the importance and likelihood need to be separately assessed - we might be less
concerned with something that, although serious, is very unlikely to occur than with something less
serious that is almost certain.
• Basic project risk matrix listing some of the risks that might be considered for a project, with their
importance and likelihood classified as high (H). medium (M), low (L) or exceedingly unlikely (—).
• So that projects may be compared the list of risks must be the same for each project being assessed.
• It is likely, in reality, that it would be somewhat longer than shown and more precisely defined.
• The project risk matrix may be used as a way of evaluating projects (those with high risks being less
favored) or as a means of identifying and ranking the risks for a specific project.

4. • Risk and Net Present Value
• Where a project is relatively risky it is common practice to use a higher discount rate to calculate net
present value.
• This addition or risk premium, might, for example, be an additional 2% for a reasonably safe project
or 5% for a fairly risky one.
• Projects may be categorized as high, medium or low risk using a scoring method and risk premiums
designated for each category.
• The premiums, even if arbitrary, provide a consistent method of taking risk into account.
• Cost Benefit Analysis
• A rather more sophisticated approach to the evaluation of risk is to consider each possible outcome
and estimate the probability of its occurring and the corresponding value of the outcome.
• Rather than a single cash flow forecast for a project, we will then have a set of cash flow forecasts,
each with an associated probability of occurring.
• The value of the project is then obtained by summing the cost or benefit for each possible outcome
weighted by its corresponding probability.

5. • Risk Profile Analysis:
• A risk profile is a quantitative analysis of the types of threats an organization, asset, project or individual faces.
• The goal of a risk profile is to provide a non subjective understanding of risk by assigning numerical values to
variables representing different types of threats and the dangers they pose.
• Each organization has its own unique risk profile, based on the assets it wants to protect, the goals it wants to
achieve, its ability to handle risks and its willingness to do so.
• Organizations use risk profiles to align their strategy and actions with their risk appetite, that is, the level of
risk they are willing to accept after the relevant controls have been put in place.
• Organizations use risk profiles to align their strategy and actions with their risk appetite, that is, the level of
risk they are willing to accept after the relevant controls have been put in place.
• In the enterprise, the ability of a management team to understand and measure gaps between the company's
risk profile and its risk appetite is an important aspect of running a successful enterprise risk
management program.
• In finance, a risk profile can be a useful tool for discussing and evaluating a potential investment's ability to
maximize return on investment while minimizing risk.
• Individuals can also develop a risk profile as they seek to make decisions that align with their risk appetite. For
example, individuals often develop a risk profile to help them make investment decisions that aren't too risky
for them but still enable them to set and reach financial objectives.

6. • Decision tree Analysis:
• A decision tree diagram is a flowchart that features the visual distinction of potential outcomes, costs, and consequences
of related choices. In this form of diagram, the flowchart initiates with one major base idea, and then various branches
are projected based on the consequences of your decisions.
• The decision tree flowchart evaluates the chance of success, risks, and benefits for every branch of consequence. Based
on each decision and outcome, you can calculate the expected value of the outcome, and by comparing each outcome,
you can choose the best course of action.
• The 'tree-like' appearance of the model gives it the name decision tree diagram analysis. This structure has four basic
elements which contribute to the clarity and precision of the decision tree analysis. They are
• 1. Alternative Branches
• Branches are the lines that branch out from a decision. These portray the viable outcomes or decisions and connect the
nodes.
• 2. Decision Nodes
• The square symbols on the decision tree are the decision nodes, and these represent the choice or decision that would
serve as an effective solution for the project.
• 3. Chance Nodes
• Represented by circular symbols, chance nodes are the multiple possible outcomes. These nodes are used in the cases
where the outcomes are uncertain.
• 4. End Nodes
• Found at the end of the diagram, the end nodes feature the outcome. Triangular symbols show these nodes.

7. • Decision Tree Analysis Steps:
• Identify Every Possible Decision
• Evaluate Possible Outcomes for Each Decision
• Perform a Thorough Analysis of Each Outcome
• Decision Tree Example