Project Management

Risk Management

• The process involved with identifying, analyzing, and

responding to risk factors throughout life cycle of the
project and in the best interest of its objectives.
• Project risk : can be simply defined as any possible
event that can negatively affect the viability of the
project
 Techniques of Risk Analysis

Analysis of Stand-Alone Analysis of Contextual Risk

risk

Corporate Market Risk

Sensitivity Scenario Risk Analysis
Analysis Analysis Analysis

Break-even
Hillier Model
Analysis

Decision
Simulation
Tree
Analysis
Analysis
 Sources of Risk
• Project Specific Risk: The earnings and cash flows of the
project may be lower than expected because of estimation
error or due to some factors specific to the project like the
quality of management.
• Competitive Risk: The earnings and cash flows of the project
may be affected by unanticipated actions of the competitors.
• Industry Specific Risk: Unexpected technological
developments and regulatory changes , that are specific to the
industry to which the project belongs, will have an impact on
the earnings and cash flows as well.
• Market Risk: Unanticipated changes in macroeconomic
factors like the GDP, growth rate, interest rate, and inflation
have an impact on all projects.
 Measures of Risk
• Risk refers to variability. A variety of measures have been
used to capture different facets of risk.
• The important ones are
• range,
• standard deviation,
• coefficient of variation.
 Measures of Risk
• Consider a capital investment whose net present value has the
following distribution.
NPV Probability
200 0.3
600 0.5
900 0.2

The probability weighted NPV works out to be

E(NPV) =∑pi×NPVi= 0.3×200+0.5×600+0.2×900 =540
Range = Highest value –Lowest Value =900-200 =700
Standard Deviation =[∑pi×(Xi-Xbar)^2]^1/2 = SQRT(0.3*(200-
540)^2+0.5*(600-540)^2+0.2*(900-540)) = 249.8
 Hillier model
• Hillier model was developed by Frederick S. Hillier and was
published in the 1961.
• It can be used for continuous and discontinuous probabilistic
events.
• Discontinuous probabilistic events: The probability of
individual year’s cash flow is multiplied with the
corresponding cash flow and summed to determine the average
cash flow for the year and then overall Net Present
Value(NPV) is determined with standard deviation , making it
continuous type probabilistic outcome.
 Case-1
• Uncorrelated Cash flows:
When there is no correlation between the cash flows occurring at
various time periods, such cash flows are termed as uncorrelated
cash flows. In such cases, the expected NPV of the project is
given as
 Case-1
• Uncorrelated Cash flows:
• It may be noted that in this case, the discount rate is the risk
free interest rate because the time value of money and the risk
factor are being treated separately. The risk factor is being
reflected in σ(NPV) of the project along with the computation
of NPV.
 Case-2
• Perfect Correlated Cash flows
• In this type of cash flows, there is perfect linear relationship
between cash flows spread over different time periods. In such
cases, the expected NPV of the project is given as
 Monte Carlo Simulation Analysis

• Monte Carlo-Method of Simulation is a technique

which statistical distribution functions are created by
using a series of random numbers
• This method of simulation is generally used to solve
problems which cannot be adequately presently by
the mathematical models or where solution of the
model is not possible by analytical method
 Random numbers

• Let’s choose say 10 random numbers( from random

number table)
• We arbitrarily choose first two digits from table , say
move forward in horizontal direction
11,36, 75, 37,26,75,10,20,19, 91
 Decision Tree Analysis
• Decision tree approach is a graphical technique that can
be used for analyzing the pros and cons of alternative
decisions and choosing the best possible course of action
• A decision tree is a diagrammatic representation of the
logical relationship between the different parts of a
complex situation and the possible outcomes of different
decisions
Symbols used in Decision Tree
Analysis
 Project Risk

Project risk is based on a simple equation

Risk = (Probability of Event)×(Consequences of

Event)
 Risk Breakdown Structure
• Lists categories and subcategories where risks
may arise

Project

Project
Technical Organizational
Management

Limited Design
Funding Estimates
Time

Specifications
Prioritization Scheduling
Adherence

Resource
Communication
Availability