Chapter quantify and compare the risk involved

Chapter 5 Summary: Performance
Relevant monetary flows are the measures for the financial performance analysis of alternatives. So, for
selecting an alternative, our first step is to identify these flows carefully. Some of the relevant flow
mistakes are allocating fixed costs, ignoring effects elsewhere in the company, including flows of
unrelated activities. The second step is to evaluate the performance of an alternative with the help of
these flows. If the flows are known with certainty, it’s a direct calculation of the desired measure which
makes the decision making easier. But if there are uncertainty in flows, then we should dig deep into
analyzing all possible outcomes of the desired measure. Risk profile is a tool used to list all possible
outcomes and their associated probabilities. EMV is the summation of weighted average of possible
outcomes * associated probabilities. For alternatives with too many possible outcomes, Bracket-Median
and Pearson-Tukey approximation Technique is used to determine the EMV. This EMV is used by the
decision makers to quantify and compare the risk involved in selecting an alternative.

Chapter 6 Summary: Risk Management
In a situation of uncertain flows, a decision maker needs the best information possible about an
uncertainty to select a better alternative with higher monetary value. EVPI (EMV with perfect
information – EMV without perfect information) is the amount a decision maker has to pay in order to
gain access to perfect information. EVII (EMV with imperfect information – EMV without information) is
the amount a decision maker should not cross this value in order to get the information. So always EVPI
is greater than EVII. EVPC (EMV with perfect control – EMV without control) is the amount paid by the
decision maker to control what will happen in future rather than simply predicting the outcome. We
should always get EVPC ;= EVPI ;= EVII. One caution is that EVPC or EVPI are approximations since we
use change in EMV to calculate them and not the entire risk profiles which triggers a decision maker to
pay even more than EVPC or EVPI to get control and perfect information. So, with this control and
perfect information we can reduce risks in the risk profile and add value and modify the decision model
to incorporate the management ideas.

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