This document discusses decision analysis and risk management. It covers decision making under certainty, ignorance, and risk. Key concepts include expected monetary value, maximax, maximin, and expected return decision rules. Under certainty, the decision maker knows the state of nature with certainty. Under ignorance, all states are possible but probabilities are unknown. Under risk, probabilities of states are known. Expected monetary value quantifies risks by multiplying probability and impact. Maximax selects the strategy with highest possible return, while maximin selects the strategy with the lowest possible loss. Expected return selects the alternative with the highest expected long-term return based on probabilities of outcomes. The document emphasizes applying decision analysis concepts to project risk management.

1. Chapter 4
Decision Analysis

2. Decision Analysis
 A set of alternative actions
 We may chose whichever we please
 A set of possible states of nature
 Only one will be correct, but we don’t know in
advance
 A set of outcomes and a value for each
 Each is a combination of an alternative action and a
state of nature
 Value can be monetary or otherwise

3. Decision Analysis
 Certainty
 Decision Maker knows with certainty what the state of
nature will be - only one possible state of nature
 Ignorance
 Decision Maker knows all possible states of nature,
but does not know probability of occurrence
 Risk
 Decision Maker knows all possible states of nature,
and can assign probability of occurrence for each
state

4. Risk Analysis and Risk Management
 Risk is made up of two parts: the probability of something
going wrong, and the negative consequences if it does.
 Risk can be hard to spot, however, let alone prepare for
and manage. And, if you're hit by a consequence that you
hadn't planned for, costs, time, and reputations could be
on the line
 This makes Risk Analysis an essential tool when your
work involves risk. It can help you identify and understand
the risks that you could face in your role. In turn, this helps
you manage these risks, and minimize their impact on
your plans.

5. What is Risk Analysis?
 Risk Analysis is a process that helps you identify and
manage potential problems that could undermine key
business initiatives or projects.
 To carry out a Risk Analysis, you must first identify the
possible threats that you face, and then estimate the
likelihood that these threats will materialize.
 Risk Analysis can be complex, as you'll need to draw on
detailed information such as project plans, financial data,
security protocols, marketing forecasts, and other
relevant information. However, it's an essential planning
tool, and one that could save time, money, and
reputations.

6. How to Use Risk Analysis
1. Identify Threats
The first step in Risk Analysis is to identify the existing and
possible threats that you might face. These can come from
many different sources. For instance, they could be:
 Human – Illness, death, injury, or other loss of a key
individual.
 Operational – Disruption to supplies and operations, loss
of access to essential assets, or failures in distribution.
 Reputational – Loss of customer or employee
confidence, or damage to market reputation.
 Procedural – Failures of accountability, internal systems,
or controls, or from fraud.

7.  Project – Going over budget, taking too long on key tasks,
or experiencing issues with product or service quality.
 Financial – Business failure, stock market fluctuations,
interest rate changes, or non-availability of funding.
 Technical – Advances in technology, or from technical
failure.
 Natural – Weather, natural disasters, or disease.
 Political – Changes in tax, public opinion, government
policy, or foreign influence.
 Structural – Dangerous chemicals, poor lighting, falling
boxes, or any situation where staff, products, or
technology can be harmed

8.  You can use a number of different approaches to carry out a
thorough analysis:
 Run through a list such as the one above to see if any of
these threats are relevant.
 Think about the systems, processes, or structures that you
use, and analyze risks to any part of these. What
vulnerabilities can you spot within them?
 Ask others who might have different perspectives. If you're
leading a team, ask for input from your people, and
consult others in your organization, or those who have run
similar projects.
Tools such as SWOT Analysis and Failure Mode and Effects
Analysis can also help you uncover threats, while Scenario
Analysis helps you explore possible future threats

9. 2. Estimate Risk
 Once you've identified the threats you're facing, you
need to calculate out both the likelihood of these threats
being realized, and their possible impact.
 One way of doing this is to make your best estimate of
the probability of the event occurring, and then to
multiply this by the amount it will cost you to set things
right if it happens. This gives you a value for the risk:
Risk Value = Probability of Event x Cost of Event

10. How to Manage Risk
 Avoid the Risk
 Share the Risk
 Accept the Risk
 Controlling Risk

11. If you choose to accept the risk, there are a number of ways in
which you can reduce its impact
 Business Experiments are an effective way to reduce risk. They involve
rolling out the high-risk activity but on a small scale, and in a controlled
way. You can use experiments to observe where problems occur, and to find
ways to introduce preventative and detective actions before you introduce
the activity on a larger scale.
 Preventative action involves aiming to prevent a high-risk situation from
happening. It includes health and safety training, firewall protection on corporate
servers, and cross-training your team.
 Detective action involves identifying the points in a process where something could
go wrong, and then putting steps in place to fix the problems promptly if they occur.
Detective actions include double-checking finance reports, conducting safety testing
before a product is released, or installing sensors to detect product defects
 Plan-Do-Check-Act is a similar method of controlling the impact of a risky
situation. Like a Business Experiment, it involves testing possible ways to reduce a
risk. The tool's four phases guide you though an analysis of the situation, creating
and testing a solution, checking how well this worked, and implementing the
solution

12. Key procedure:
1. Expected Monetary Value (EMV): Parameters of Decision
 Beginning With a Qualitative Risk Analysis...
After conducting a Qualitative Risk Analysis, you’ll have a list of risks
with a priority and urgency assigned. By using Expected Monetary Value,
you can quantify each risk to determine whether your qualitative analysis
is backed by numbers. Expected Monetary Value is a recommended tool
and technique for Quantitative Risk Analysis in Project Risk
Management.
 Steps to Calculate Expected Monetary Value (EMV)
 To calculate the Expected Monetary Value in project risk management, you
need to:
 Assign a probability of occurrence for the risk.
 Assign monetary value of the impact of the risk when it occurs.
 Multiply Step 1 and Step 2.
The value you get after performing Step 3 is the Expected Monetary Value. This value is
positive for opportunities (positive risks) and negative for threats (negative risks). Project
risk management requires you to address both types of project risks.

13.  Expected Monetary Value Example for Project Risk Management
Suppose you are leading a construction project. Weather, cost of construction material,
and labor turmoil are key project risks found in most construction projects:
 Project Risks 1 - Weather: There is a 25 percent chance of excessive snow
fall that will delay the construction for two weeks which will, in turn, cost the
project $80,000.
 Project Risks 2 - Cost of Construction Material: There is a 10 percent
probability of the price of construction material dropping, which will save the
project $100,000.
 Project Risks 3 - Labor Turmoil: There is a 5 percent probability of
construction coming to a halt if the workers go on strike. The impact would
lead to a loss of $150,000. Consider your industry and geographic area to
determine whether this risk would have a higher probability.
Note: Regardless of the type of project, the golden rules of project risk
management do not change. Hence, though this example is from the
construction industry, the theory is applicable to other industries, such as
software development and manufacturing
Next, let's see how to quantify the project risks by calculating the Expected
Monetary Value of each risk.

14.  Expected Monetary Value Calculation for Project Risk
Management
In this Expected Monetary Value example, we have two negative project risks (Weather
and Labor Turmoil) and a positive project risks (Cost of Construction Material). The
Expected Monetary Value for the project risks:
• Weather: 25/100 * (-$80,000) = - $ 20,000
• Cost of Construction Material: 10/100 * ($100,000) = $ 10,000
• Labor Turmoil: 5/100 * (-$150,000) = - $7,500
Note: Though the highest impact is caused by the Labor Turmoil project risk, the
Expected Monetary Value is the lowest. This is because the probability of its occurring
is very low.
This means that if the:
• Weather negative project risks occurs, the project loses $20,000,
• Cost of Construction Material positive project risks occurs, the project gains $10,000,
and
• Labor Turmoil negative project risks occurs the project loses $ 7,500
The project’s Expected Monetary Value based on these project risks is:
-($20,000) + ($10,000) – ($7,500) = - $17,500

15. Therefore, if all risks occur in the construction project, the project would lose
$17,500. In this scenario, the project manager can add $17,500 to the budget to
compensate for this. This is a simplistic Expected Monetary Value calculation
example. Another technique used to calculate complex Expected Monetary Value
calculations is by conducting Decision Tree Analysis. This analysis helps while
making complex project risk management decisions.
As a project manager, you may apply different production techniques to
minimize risk. For example, if this example was based on software development
or manufacturing, the project manager could use Lean thinking to reduce waste
and minimize risk. However, the method for computing Expected Monetary
Value during project risk management would not change.

16. 2.Expected Utility of Profits and payoff tables
 According to expected utility theory, decisions are made to maximize the
manager’s expected utility of profits
 Such decisions reflect risk-taking attitude
 Generally differ from those reached by decision rules that do not consider
risk
 For a risk-neutral manager, decisions are identical under maximization of
expected utility or maximization of expected profit

17. Decision Making Under Certainty

18. Decision Making Under Ignorance
– Payoff Table
Kelly Construction Payoff Table (Prob. 8-17)
Low (50 units) Medium (100 units) High (150 units)
Build 50 (8000*50)= 400000 400,000 400,000
Build 100 (8000*50-6000*50)=100000 800,000 800,000
Build 150 (50*8000-100*6000)=-200000 (100*8000-50*6000)=500000 1,200,000
State of Nature
Demand
Alternative
Actions

19. Decision Making Under Ignorance
 Maximax
Select the strategy with the highest possible
return
 Maximin
Select the strategy with the smallest possible
loss
 LaPlace-Bayes
All states of nature are equally likely to occur.
Select alternative with best average payoff

20. Maximax:
The Optimistic Point of View
 Select the “best of the best” strategy
 Evaluates each decision by the maximum possible
return associated with that decision (Note: if cost data
is used, the minimum return is “best”)
 The decision that yields the maximum of these
maximum returns (maximax) is then selected
 For “risk takers”
 Doesn’t consider the “down side” risk
 Ignores the possible losses from the selected
alternative

21. Maximax Example
Low (50 units) Medium (100 units) High (150 units) Max
Build 50 400,000 400,000 400,000 400,000
Build 100 100,000 800,000 800,000 800,000
Build 150 (200,000) 500,000 1,200,000 1,200,000
State of Nature
Maximax
CriterionDemand
Alternative
Actions
Kelly Construction

22. Maximin:
The Pessimistic Point of View
 Select the “best of the worst” strategy
Evaluates each decision by the minimum
possible return associated with the decision
The decision that yields the maximum value
of the minimum returns (maximin) is selected
 For “risk averse” decision makers
A “protect” strategy
Worst case scenario the focus

23. Maximin
Low (50 units) Medium (100 units) High (150 units) Min
Build 50 400,000 400,000 400,000 400,000
Build 100 100,000 800,000 800,000 100,000
Build 150 (200,000) 500,000 1,200,000 (200,000)
State of Nature
Maximin
CriterionDemand
Alternative
Actions
Kelly Construction

24. Decision Making Under Risk
 Expected Return (ER)*
 Select the alternative with the highest (long term)
expected return
 A weighted average of the possible returns for
each alternative, with the probabilities used as
weights
* Also referred to as Expected Value (EV) or Expected
Monetary Value (EMV)
**Note that this amount will not be obtained in the short
term, or if the decision is a one-time event!

25. Expected Return
Low (50 units) Medium (100 units) High (150 units) ER
Build 50 400,000 400,000 400,000 400,000
Build 100 100,000 800,000 800,000 660,000
Build 150 (200,000) 500,000 1,200,000 570,000
Probability 0.2 0.5 0.3 1.0
State of Nature
Expected
ReturnDemand
Alternative
Actions

26. Conclusions
 Most people often make choices out of habit or tradition, without going
through the decision making process steps systematically
 Decisions may be made under social pressure or time constraints that
interfere with a careful consideration of the options and consequences
 Decisions may be influenced by one's emotional state at the time a decision
is made. When people lack adequate information or skills, they may make
less than optimal decisions
 Even when or if people have time and information, they often do a poor
job of understanding the probabilities of consequences. even when they
know the statistics; they are more likely to rely on personal experience than
on information about probabilities
 The fundamental concerns of decision making are combining information
about probability with information about desires and interests

27.  Key benefits of implementing risk management include fewer shocks and
unwelcoming surprises , effective use of resources, reassuring stakeholders
and being prepared for threats and opportunities during the course of the
project
 In our projects there traps that waste our time damage our reputation upset the
customer ,waste our money , hurt people , and clearly we need to minimize
them and avoid them. And on the other hand we need to get benefits out of
them (traps), that need to done by managing risky projects in two aspects
simultaneously:
 We have to stop bad things from happening
 Make good things happen
in a way to create value while stopping bad things, this why risk management is
what stands for , is by seeing things go wrong and stopping them and things go
right and make them happen that’s why risk may contain threat and opportunity.
However if it is negative risks you need to minimize them , monitor them , and
keep them under control ,and if it is positive risk you put your resources to
maximize the opportunity