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VERY LOW LOW MODERAT E HIG H HIGHLY LIKELY PROBABLE UNLIKELY VERY UNLIKELY CLASS I RISKS CLASS II RISKS CLASS III RISKS CLASS IV RSIKSFigure 71: Risk Determination Matrix
For risks which are having a very high negative consequence and a very low likelihood, it must be paid with special attention. Examples of this kind of risks are multiple fatalities, massive environmental incident or plant failure. These risks must be identified and noted in the Risk register as special cases. It must be urgently evaluated and treated separately from the standard risk analysis process.
ii) The Expected Monetary Value
The phrase “Expected Monetary Value” refers to a specific analytical technique or analysis in which a calculation is made to determine the average of all potential outcomes when the future includes a number of particular scenarios that may or may not ultimately happen. These scenarios can all be interpreted as potential happening individually, or that may happen in various groups. One common utilization of this technique takes place within a technique such as “Decision Tree Analysis”. It is also recommended that a project team utilize simulations and modelling when conducting cost and/or a schedule risk analysis because it is in reality significantly more powerful and is typically subject to less erroneous application than other analytical methods. The expected monetary value analysis can be conducted at any time during the project life cycle but should be done as soon as possible. The following details will illustrate how to use the “Decision Tree Analysis” in Project Risk Management. Decision Tree Analysis
Decision Trees are excellent tools for helping you to choose between several courses of action. They provide a highly effective structure within which you can lay out options and investigate the possible outcomes of choosing those options. They also help you to form a balanced picture of the risks and rewards associated with each possible course of action.
You start a Decision Tree with a decision that you need to make. Draw a small square to represent this towards the left of a large piece of paper. From this box draw out lines towards the right for each possible solution, and write that solution along the line. Keep the lines apart as far as possible so that you can expand your thoughts. At the end of each line, consider the results. If the result of taking that decision is uncertain, draw a small circle. If the result is another decision that you need to make, draw another square. Squares represent decisions, and circles represent uncertain outcomes. Write the decision or factor above the square or circle. If you have completed the solution at the end of the line, just leave it blank. Starting from the new decision squares on your diagram, draw out lines representing the options that you could select. From the circles draw lines representing possible outcomes. Again make a brief note on the line saying what it means. Keep on doing this until you have drawn out as many of the possible outcomes and decisions as you can see leading on from the original decisions
Figure 82: Example Decision Tree (Should we develop a new product or consolidate?)
Once you have done this, review your tree diagram. Challenge each square and circle to see if there are any solutions or outcomes you have not considered. If there are, draw them in. If necessary, redraft your tree if parts of it are too congested or untidy. You should now have a good understanding of the range of possible outcomes of your decisions.
Evaluating the Decision Tree
Now you are ready to evaluate the decision tree. This is where you can work out which option has the greatest worth to you. Start by assigning a cash value or score to each possible outcome. Estimate how much you think it would be worth to you if that outcome came about.
Next look at each circle (representing an uncertainty point) and estimate the probability of each outcome. If you use percentages, the total must come to 100% at each circle. If you use fractions, these must add up to 1. If you have data on past events you may be able to make rigorous estimates of the probabilities. Otherwise write down your best guess.
Figure 93: Example Decision Tree (Should we develop a new product or consolidate?)
Calculating Tree Values
Once you have worked out the value of the outcomes, and have assessed the probability of the outcomes of uncertainty, it is time to start calculating the values that will help you make your decision. Start on the right hand side of the decision tree, and work back towards the left. As you complete a set of calculations on a node (decision square or uncertainty circle), all you need to do is to record the result. You can ignore all the calculations that lead to that result from then on.
Calculating The Value of Uncertain Outcome Nodes
Where you are calculating the value of uncertain outcomes (circles on the diagram), do this by multiplying the value of the outcomes by their probability. The total for that node of the tree is the total of these values.
In the example in Figure 93 , the value for 'new product, thorough development' is:
0.4 (probability good outcome) x $1,000,000 (value) = $400,000 0.4 (probability moderate outcome) x $50,000 (value) = $20,000 0.2 (probability poor outcome) x $2,000 (value) = $400 + $420,400 Table 4: Value of new product after development 0.4 (probability good outcome) x $1,000,000 (value) = $400,000 0.4 (probability moderate outcome) x $50,000 (value) = $20,000 0.2 (probability poor outcome) x $2,000 (value) = $400 + $420,400
Figure 104: Example Decision Tree (Should we develop a new product or consolidate?) Calculating the Value of each Decision Nodes
When you are evaluating a decision node, write down the cost of each option along each decision line. Then subtract the cost from the outcome value that you have already calculated. This will give you a value that represents the benefit of that decision. Note that amounts already spent do not count for this analysis – these are 'sunk costs' and (despite emotional counter-arguments) should not be factored into the decision. When you have calculated these decision benefits, choose the option that has the largest benefit, and take that as the decision made. This is the value of that decision node.
Figure 115: Example Decision Tree (Should we develop a new product or consolidate?)
In this example, the benefit we previously calculated for 'new product, thorough development' was $420,400. We estimate the future cost of this approach as $150,000. This gives a net benefit of $270,400. The net benefit of 'new product, rapid development' was $31,400. On this branch we therefore choose the most valuable option, 'new product, thorough development', and allocate this value to the decision node.
Result
By applying this technique we can see that the best option is to develop a new product. It is worth much more to us to take our time and get the product right, than to rush the product to market. It is better just to improve our existing products than to botch a new product, even though it costs us less.
b) Identify the various risk exposures in a large project that can be effectively managed by transferring them to various other external competent parties. Projects are complex undertakings involving a unique set of tasks and activities conducted within a set of constraints to meet defined objectives. One of the key areas requiring proactive management within projects is risk, arising from uncertainties which could affect achievement of objectives. Risk in projects is also complex, arising from a wide range of sources and having a broad scope of possible effects on the project. Given these two dimensions of project complexity, in both the tasks to be performed and the risks inherent in the project environment, managing the relationship between project work and project risk is a key success factor for every project manager.
As discussed previously, project complexity is characterized by two dimensions: structural complexity and uncertainty. These two factors are the two main risk exposure usually found in large projects and can be effectively managed using tools and techniques. Structural complexity can be defined as a project for example in the design-and-manufacture industry where the product is the physical deliverable (the product being designed and manufactured). We can also see in a different perspective where a project to develop a more complex product must obviously or normally be a more complex project but it is better to distinguish the cause and effect of product type of complexity first.
c) You have $1,000,000 worth of equipment at the job site and wish to minimize your risk of direct property damage by taking out an insurance policy. The insurance company provides you with their statistical data as shown below:
Assuming that the insurance company adds on $300 for handling and profit and uses expected value to calculate premiums, calculate:
i) The expected loss and its variance;
Property
Damage Type Probability % Loss Amount (RM) Probability Loss Amount (RM)
Total 0.0002 1,000,000 200
Medium 0.0008 400,000 320
Low 0.001 200,000 200
No Damage 0.998 0 0
Table 5: Probability Loss Amount Thus expected value loss = E(X) = ai Pr(X = ai)
= (200 + 320 + 200 + 0)/1 = RM 720.00 Mean =(1,000,000 + 400,000 + 200,000 + 0)/4 = 400,000 Variance: Property Damage Type Probabilit y % Loss Amount ($) Total 0.02 1,000,000 Medium 0.08 400,000 Low 0.10 200,000 No Damage 99.8 0
Var (X) = E( (X - μ)2) =
ı2 = _(ai - μ)2 Pr(X = ai)
= (1,000,000-400,000)2 x 0.0002 + (400,000-400,000)2 x 0.0008 + (200,000-
400,000)2 x 0.001 + (0-400,000)2 x 0.998
= 159,792,000,000
ii) The premium the insurer is likely to charge for: - full cover against any loss
- cover against losses in excess of $200,000 Likely premium charge:
Full cover against any loss:
= RM720 + RM300 = RM 1,020.00
Therefore, covering against losses in excess of RM200,000. = (200 + 320) ÷ (0.999) = 520/0.999 = RM 520.52
PART B
a) Describe the key documents that contain information on the financial position of a firm.
In order to best understand the financial position of a firm, one must start from the basics. There are several key documents that contain information and it is called the financial statements. These financial statements will help to determine a firm's financial position at a point in time and over a period of time as well as the cash position at any point in time. Many businesses fail because the owner loses a grip on the firm's financial position. Below are the details for each key document that are essential to determine the financial position of a firm.
Income Statement
The income statement is also called the profit and loss statement. It is the major statement for measuring a firm's profitability over a period of time. The income statement is developed in a step-by-step process starting with the amount of revenue that a firm have earned. Then subtract each item your firm has expensed to see what your profit or loss is after each is deducted. The income statements can be prepare for a short period of time like a month and
for tax purposes, it can be extend out and develop the firm income statement for the tax year.
Statement of Retained Earnings
The Statement of Retained Earnings is the second financial statement must be prepare in the accounting cycle. After the firm arrive at its profit or loss figure from the income statement, it must prepare this statement in order to see what is the total retained earnings to date are and
how much will the firm pay out to its investors in dividends, if any. Total retained earnings are then transferred to the balance sheet.
Balance Sheet
The balance sheet is a statement showing what the firm own (assets) and what it owes (liabilities and equity). The firm assets must equal its liabilities (debt) plus the equity (owner's investment). The firm may have used its liabilities and equity to purchase assets. The balance sheet shows the firm's financial position with regard to assets and liabilities/equity at a point in time.
Statement of Cash Flows
Even if the firm is turning a profit, it may be falling short because it does not have the have adequate cash flow. It is just as important to prepare a Statement of Cash Flows as it is to prepare the income statement and balance sheet. This statement compares two time periods of financial data and shows how cash has changed in the revenue, expense, asset, liability, and equity accounts during those time periods. The statement divides the cash flows into operating cash flows, investment cash flows, and financing cash flows. The final result is the net change in cash flows for a particular time period and gives the owner a very comprehensive picture of the cash position of the firm. These four financial statements are prepared at the end of the accounting cycle and should be prepared in this order. Information
from the Income Statement comes from the revenue and expense accounts on the general
ledger and information for the Statement of Retained Earnings comes from the Income Statement and the dividend account. The Balance Sheet is prepared next and the information is taken from the asset, liability and equity accounts on the general ledger as well as from the
Statement of Retained Earnings. Last, the Statement of Cash Flows is prepared from all the previous financial statements. Financial statement can be prepared for a company for any length of time and at any point in time. Some companies prepare financial statements monthly to keep a tight handle on the financial position of the firm. Other companies have a longer accounting cycle. Financial statements must be prepared at the end of the
b) You are the project manager for a chosen new project activity to be undertaken by a firm. Discuss, in the contexts of this new project.
i) The major risk exposures the firm might exposed to:
Risk is another name for uncertainty, which include the complete range of positive and negative impacts on the future outcomes of a project. A project’s exposure to risk can range from acts of nature to simple mistakes. The usual end result of a deviation from the original project plan, or schedule is additional cost to the project. By using risk management methodology, we can limit the exposures that can be caused by these events. As a project manager, any new project activity assigned may have its risk exposures the firm might expose to. In this example of a new project activity, we’ll take the Boeing Company to explain the risk exposures it may face in order to design and manufacture a new commercial airplane. The Boeing Company is among the largest global aircraft manufacturers and the third largest aerospace and defence contractor in the world based on defence related revenue. This year, the Boeing Company will manufacture the new wide body 747-8 for the world commercial airline markets. The company will design and manufacture a new airplane and it requires ten full years to complete from research level up to signing a new contract to customers. This project will requires a financial investments of more than USD5 billion and surely a project risk management must be implemented to overcome the major risk exposures. Below are the forecast of major risks exposures explained in more detail.
In order to undertake this huge project, The Boeing Company must have financial stability to design and manufacture one of the best commercial transport aircraft in the world. This requires sufficient money to build and construct the airplane. The company must up front allocate sufficient budget to fund the project and this will more or less influence the company’s other business field sales performance since it is focusing all their resources for this main project. The company also needs to strategically calculate the number of planes sold based on customer request. This is crucial since it will determined the payback period for the Boeing Company to receive back their initial financial funding to complete the project. Up front funding and payback period based upon number of planes sold
Market
Air travel remains a large and rowing industry. It facilitates the growth, world trade, international investment and tourism and is therefore central to the globalization taking place in many other countries. The Boeing Company must forecast the customer expectations on cost, configuration and amenities. This factor is based on year life of the plane spanning from 30 to 40 years.
Technical
A conventional commercial aircraft lifetime usually is based on the landing and takeoff cycles and sometimes on the pressurization cycles. Each time an aircraft is pressurized during flight, its fuselage and wings are stressed. Both the fuselage and wings are made of large, plate-like parts connected with fasteners and rivets, and over time, cracks develop around the
fastener holes due to metal fatigue. Because of the long lifetime for an airplane, the Boeing
Company must forecast the current technology and its impact on cost, safety, reliability and maintainability.
Coordination of manufacturing and assembly of a large number of subcontractors without impacting cost, schedule, quality and safety.
ii) How you propose, in broad terms, to mitigate the downside effects of the undesirable risks that have been identified; and
Financial
• Funding by life cycle phases
• Continuous financial risk management
• Sharing risk with subcontractors
• Risk re-evaluation based upon sales commitments Market
• Close customer contact and input
• Willingness to custom-design per customer
• Develop a baseline design that allows for customization Technical
• A structured change management process
• Using proven design rather and technology rather than unproven designs and high risk technology
• Parallel product improvement and new product development process Production
• Close working relationships with subcontractors
• Lesson learned from other new airplanes program
• Use of learning curves.
iii) How you would assess the risk-bearing capacity of the firm in the light of implementing this project.
There is no single number that represents a company’s risk-bearing capacity. A risk-bearing capacity analysis looks at:
• Financial Strength
• Competitive Dynamics
• Risk Management Systems
These dimensions are looks into individually and in interaction with one another to provide both qualitative and quantitative indicators of overall capacity, as well as currently employed and identified reserve capacity. To measure the risk bearing capacity for the Boeing Company to embark on a new project developing a new fleet of airplanes requires an analysis on above dimensions to successfully deliver the project. The first assessments are to measure
the company financial strength or capacity to manage the project. Boeing is organized into
two business units: Boeing Commercial Airplanes and Boeing Defence, Space & Security. Supporting these units is Boeing Capital Corporation, a global provider of financing solutions. Boeing Capital Corporation is a global provider of financing solutions. Working closely with Commercial Airplanes and Defence, Space & Security, Boeing Capital Corporation arranges, structures and provides financing to facilitate the sale and delivery of Boeing commercial and military aircraft, satellites and launch vehicles. With a year-end 2009
portfolio of approximately $5.7 billion, Boeing Capital Corporation combines Boeing's financial strength and global reach, detailed knowledge of Boeing customers and equipment, and the expertise of a seasoned group of financial professionals. From this explanation, there’s no doubt the Boeing Company backed by The Boeing Capital Corporation will have the sufficient cash flow to provide payments for contractors in manufacturing and delivery of the its fleet of commercial aircrafts.
The second assessment is to analyze the competitive dynamics of The Boeing Company compared to other aviation company such as Airbus and Lockheed Martin Corporation. Competitive dynamics refers to a company’s position in the marketplace relative to its