Risk Management – decision tree

Assignment: build out a decision tree, compute the EMV of each decision, and answer the two questions
below. Upload the completed assignment for credit.

Scenario: suppose your organization is using a legacy software. Some influential stakeholders believe
that by upgrading this software your organization can save millions, while others feel that staying with
the legacy software is the safest option, even though it is not meeting the current company needs. The
stakeholders supporting the upgrade of the software are further split into two factions: those that
support buying the new software and those that support building the new software in-house. Confusion
reigns in the meeting room with stakeholders pointing out negative risks for each option.

By exploring all possibilities and consequences, you can quantify the decisions and convince
stakeholders. This is known as Decision Tree Analysis.

In this scenario, you can either:

• Build the new software: To build the new software, the associated cost is $500,000.

• Buy the new software: To buy the new software, the associated cost is $750,000.

• Stay with the legacy software: If the company decides to stay with the legacy software, the
associated cost is maintenance and will amount to $100,000.

1. Build a decision tree using the 3 scenarios above.

 The Build the New Software and Buy the New Software options will lead to either a successful
deployment or an unsuccessful one. Add this detail to the decision tree.

o If the deployment is successful then the impact is zero, because the risk will not
have materialized. Add this detail to the decision tree.
o However, if the deployment is unsuccessful, then the risk will materialize and the
impact is $2 million. Add this detail to the decision tree.

 The Stay with the Legacy Software option will lead to only one impact, which is $2 million,
because the legacy software is not currently meeting the needs of the company, and it won’t
meet the needs should there be growth (in this example, we have assumed that the company
will have growth). Add this detail to the decision tree.

At this point, you should have something that looks like this (first one is done for you):
Next set of detail:

• The risk associated with Build the New Software is assessed at 40%.

• The risk associated with Buy the New Software is assessed at 5%.

• The risk associated with Stay with the Legacy Software is assessed at 100%.

2a. Using these values, determine the EMV (expected monetary value) for each decision. Recall that
$2,000,000 is the impact. The first has been done for you:

Build the New Software: $2,000,000 x 0.4 = $800,000 (risk * risk value)

Buy the New Software:

Staying with Legacy Software:

2b. Now add up the setup costs to each EMV. Recall the cost of each option. The first has been done
for you:
 Build the New Software: $500,000 + $800,000 = $1,300,000 (cost + EMV)

Buy the New Software:

Staying with Legacy Software:

3. Using your decision tree and the values of each decision, answer the following questions:

a) Which option is the most expensive (highest EMV)? Build, Buy, or Stay with Legacy?
b) What is the best decision (lowest EMV)? Build, Buy, or Stay with Legacy?