Project

Management
Course: 504
 Learning Objective

Chapter # 4
Project Risk
Analysis
Topic of the session

• Risk Analysis &

Social Cost benefit
Analysis
• Risk is inherent in almost every business decision. More so in capital
budgeting decisions as they involve costs and benefits extending over a
long period of time during which many things can change in unanticipated
ways.For the sake of expository convenience, we have assumed so far
that all investments being considered for inclusion in the capital budget
had the same risk as those of the existing investments of the firm. Hence
the average cost of capital was used for evaluating every project.
Investment proposals, however, differ in risk. A research and development
project may be more risky than an expansion project and the latter tends
to be more risky than a replacement project. In view of such differences,
variations in risk need to be evaluated explicitly in capital investment
appraisal.Financial analysts generally evaluate capital investments in two
phases. In the first phase, the analyst tries to calculate the NPV, IRR and
other measures of investment worth on the basis of what he thinks is
most likely to happen. In the second phase, the analyst identifies the
underlying sources of risk
• R isk is inherent in almost every business decision. More so in
capital budgeting decisions as they involve costs and benefits
extending over a long period of time during which many things
can change in unanticipated ways.For the sake of expository
convenience, we have assumed so far that all investments being
considered for inclusion in the capital budget had the same risk as
those of the existing investments of the firm. Hence the average
cost of capital was used for evaluating every project. Investment
proposals, however, differ in risk. A research and development
project may be more risky than an expansion project and the latter
tends to be more risky than a replacement project. In view of such
differences, variations in risk need to be evaluated explicitly in
capital investment appraisal.Financial analysts generally evaluate
capital investments in two phases. In the first phase, the analyst
tries to calculate the NPV, IRR and other measures of investment
worth on the basis of what he thinks is most likely to happen. In
the second phase, the analyst identifies the underlying sources of
risk
 Risk
Risk is inherent in almost every business decision. It is the variability of actual results in relation to
the excepted results. Risk is the possibility of financial loss. IT exists when a decision maker is in a
position to assign the probable outcome of a business on project. According to Weston &Bringham,
"Risk is the chance that some unfavorable events will occur.
Finally we can conclude that risk is the deviation between the achievement and the expectation.
Q-2: Different types of risk:
Three types of risk related to a project. These arc,
1) Stand-alone risk
2) Firm risk
3) Market risk
Stand-alone risk: stand-alone risk is the risk associate will a project when it is held by itself in
isolation, not in combine with another project. That is, it represents the risk of a project when it is
viewed in isolation. Every project is separated from one another and the risk of every project is
measured by standalone risk.
Firm risk: this reflects the contribution of a project to risk of the film. There are many project in film,
if any new project is taken them the risk of existing project may increase of decrease so firm risk
increase the total risk of the project as a result of accepting a new project. If the risk of new project is
higher them the average risk of a project them.

Market risk: Risk involved in the marketing system of a project is called market risk. Market risk
helps to calculate weighted average cost of capital (WACC) of a particular project.

1. High market risk -high WACC

2. Low market risk- low WACC
 Risk vs. Uncertainty

Risk Uncertainty

1. Risk is the Chance that some unfavorable events Uncertainty means some events that may happen or
will occur not.

2. Risk can be measured 2. Uncertainty can not be measured.

3. Risk can be avoided. 3. Uncertainty cannot be avoided.

4. Risk is be controlled. 4. Uncertainty cannot be controlled.

5. Risk can be reduced. 5. Uncertainty cannot be reduced

6. Risk can be converted into frequency distribution 6. Uncertainty cannot be converted into frequency
distribution.

7. Statistical measured are used for measuring risk 7. Statistical measured are not used for measuring
i.e. standard deviation, variance, Co-efficient of risk i.e. standard deviation, variance, Co-efficient of
variation. variation.
How can risk be measured in
project management?

• Risk is the variability of actual results in

relation to the expected results. A variety of
measures have been used to capture different
types of risk. Those are
 Range
 Standard deviation
 Variance
 Co-efficient of variation
 Sensitivity analysis
 Performance analysis
• Range: Range is the simplest Measure of risk difference between the highest value
and lowest
• Range =highest value- lowest
• Value High range -high risk of the project
• Low Range-low risk of the project
• Standard deviation: SD is the root of the mean. The deviation being the difference
between an outcome and the expected mean value of all outcomes.
•
• Where, Pi= the probability associated with the value
• Xi= ith value
• X (bar) = Expected Value.
• High SD-high risk of the project
• Low SD-low risk of the project
Variance: variance is another important measure of measuring risk. It is the square of
SD.
• High variance high risk of the project
• Low variance-low risk of the project

• Co-efficient of aviation: a relative measure of risk is the co-efficient of Variation.

• High CV-high risk of the project & Low CV-low risk of the project
Perspectives on Risk Regardless of the risk measure employed,
there are different perspectives on risk. You can view a project
from at least three different perspectives. These are:Stand-alone
risk isolation. This represents the risk of a project when it is
viewed inFirm risk Also called corporate risk, this reflects the
contribution of a project to the risk of the firm.Systematic risk This
represents the risk of a project from the point of view of a
diversified investor. It is also called market risk.This chapter
focuses on stand-alone risk and the following chapter examines
firm risk and market risk. There are several reasons for starting
with stand alone risk analysis:Measuring a project's stand-alone
risk is easier than measuring its corporate risk and far easier than
measuring its market risk.In most of the cases, stand-alone risk,
corporate risk, and market risk are highly correlated. If the overall
economy does well, the firm too would do well. Further, if the firm
does well, most of its projects would do well. Thanks to this high
correlation, stand-alone risk may be used as a proxy for corporate
risk and market risk.
• The proponent of a capital investment is likely to judged on the
performance of that investment. Hence he will naturally be
concerned about its stand alone risk and not about its
contribution to the risk of the firm or the risk of a diversified
investor.In most firms, the capital budgeting committee
considers investment proposals one at a time. The committee
often does not have the time or information or expertise to fully
consider the interactions of the investments with the other
investments of the firm or its shareholders.
• Sensibility analysis: Financial institutions carry out sensitively
analysis to assess the impact of adverse changes in the operating
conditions of the project on its variability. The standard
sensibility involves assessing the impact of 10% adverse
variation in selling price, quantity and operating on IRR, debt
service coverage Ratio and Break-even point (BEP).
•
•
• Performance analysis: Under this method, risk is measured
based on performance. The portion of work completed is
compared with the standard required for that portion of work.
The variability of the performance of the project below standard
is the risk. Higher the variability, higher the risk and vice-versa.
 Factors of project Analysis
• Having a talented project manager is the first step to actual
project success, but there are other important factors that
contribute largely to a project’s outcome. It takes careful
planning, attention to detail and effective communication to make
a project succeed. With vigilant management and a strong project
closing, a company can consistently reach project success.
• 1. Smart People
• Without the right team in place, any strategy and plan has the
potential of completely falling apart. Because of this, the core
project staff, expert resources, suppliers and all stakeholders
should be part of the team dynamic. All of those involved must
have commitment to the group, share similar visions for the
projects and strive for overall success.
•
 What is shadow price?
•Shadow price is not the actual price of the product as well as it is not
market price of the product. It is the derived price of the product. When
a new product is produced then the price of this product is unknown.
The price of the product depends on its substitute product price and it is
called shadow price.
Why is shadow price used in social cost benefit analysis of a
project?
•Shadow price is used n social cost benefit analysis. Because
•1) When the market prick of the product is unknown.
•2) If the perfect market is not exist.
•3) If political and social objectives are involved in the economy.
•4) Shadow price is used to calculate social cost benefit.
•5) Where imperfect market is exist.
•Besides these social cost benefits analyses, shadow price is used in
developing country not in developed country.
•
• What are the sources of labour?
• There are three types of sources of labour. These are
• a) Taking labour away from other firm
• b) Induce production of new labour
• c) Imported labour
• Taking labour away from other firm: When a project collects
the labour from other firms the shadow price would be what the
other users of labour willing to pay for his labour.
• Induce production of new labour: Labour can be created in
various ways. Such as
 Unemployed person is converted into labour
 prart time labour is converted into full time labour
 Unskilled labour is converted into skilled labour
 Rural labors converted into urban labor
• Imported labour: If labours are not available in the local
market, labour may be imported from international market.
• Q-4: How is the shadow price of labour calculated?
• Shadow price of labor can be calculated under two methods.
These are follows
• 1. UNIDO method
• 2. L.M method

• UNIDO method:
•  Received in the previous firm.
•  When an unemployed person is converted into labour
then shadow price of the labour is zero.
•  When a part time labour is converted into labour then the
shadow price shadow price of the labour is eqaul to the
marginal cost of production.
•  When unskilled is converted into skilled labour then the
shadow price of the labour would be the training cost labour.
• 
• when rural labour converted into Urban
•  When a labour is taken from other then the shadow
price is higher than with amount he recived in the previous firm
•  In case of imported labour the shadow price would be
what amount he demands.

• L.M method:
• SWR =
• Where, SWR= shadow Wages rate

• M- Marginal product of the labour

• C=additional resources devoted to consumption

1/s- the value of unit of committed resources.
C=consumption of labour
 UNIDO method VS. L.M method

subject UNIDO method L.M method

published UNIDO METHOD WAS LM method was
PUBLISHED IN 1972 published in 1969
2.Establishm UNIDO method was LM method was
ent Established by the United Established by the
Nations industrial development economist of MD. Littel
organization. and A. Mirreies.
factory UNIDO factors are considered Lm method factors are
consideration in terms of considered considered
consumption UNIDO method is considered LM method is measured
in terms of considered by cost of benefit in
terms of international
price.
Similarities: some similarities in followings-
1. In Case of calculation shadow rate, specially the savings
of foreign currency and unskilled labour.
2. Consideration of equity
3. Uses of discounted cash flow analysis.
• Q-6. Social cost-benefit analysis vs. financial analysis:
• In the social cost benefit analysis, we can predetermine
whether the society and nation would be able to earn any
opportunity or any negative impact of it through the help of
establishment of the project.
• On the other hand, in case financial analysis, we my
predetermine that whether the project would be able to earn
profit or loss.
•
•
 Some differences
Financial Analysis Social Cost-Benefit Analysis
Ian financial analysis, all the direct related income and 1. All the direct and indirect even the territory related
expenditure are recorded in the accounts income and expenditure are recorded cost benefit
analysis.

2.Financial analysis, only commercial profitability is 2. In case of SCBA, the whole input and output of the
measured/considered. project is determined on the basis of social price/
social profitability is considered.

3. In case of financial analysis, the existence of 3. In case of SCBA, the existence of externalities of
externalities of the project is avoided. the project is considered with special importance.

4. In case of Financial analysis, the probable consumer 4. In SCBA, it is considered

surplus of the project is not considered.

5. Savings of the common people is ignored. 5. In SCBA, it is considered

6. The scope of financial analysis is comparatively 6. The scope of SCBA is comparatively large.
narrow.
• Q-1. What is decision tree?
• For decision making of an organization, management must
have relevant factors. Some of the relevant factors have also
some sub factors which arc also to be considered. It is called
decision tree analysis.
• In other words, decision tree analysis is the graphical display or
the relationship between a present decision and future event,
future decision and their consequences. In fact, it is a useful
tool for analyzing sequential decision in the face of risk.
•
• Q-2. Discuss the steps to be followed in preparing derision
tree analysis.
• The key steps in decision tree analysis are-
• Identification of the alternatives delineate the alternatives with
problems evaluate the alternatives calculate the expected
money value.
• 1. Identification of the alternatives: The first step in decision
ree analysis the identification of the alternatives. We have to
select best alternative among one set of alternatives.
•
• 2. Delicate the alternatives with the problem: The decision
tree reflects in a diagrammatic from the nature of the decision
situation in terms of alternative course of action with the
problems and change chance, outcomes which have been
identified in the first step of the analysis.
• 3. Evaluate the alternatives: Once the alternative are
delineated, these are to be evaluated in terms of financial &
non-financial consideration.
• 4. Evaluate the expected monetary value: This is the final
stage of decision tree analysis, in this stage, monetary value of
each combination of decision alternative and chance outcome
is to be calculated.
Expected value= (Estimated value ×associate probability)
• Q-1. What is scheduling?
• Scheduling is the determination of time required for execution
of each operation and the time order in which each operation
has to be carried out, to meet the plan objectives.
•
• According to R.Martino, "a schedule depicts the expected
start and finish time of each job. Lt is produced by allocating
resources up-to the limit of availability, according to the
requirements given by the plan".
• Q-2. Why is scheduling done?
• Scheduling is done for the following reasones-
• 1. To know the starting and ending time of each job o of each
job of a project.
• 2. To know the required time for overall project.
• 3. The resources are allocated to each job on the basis of
scheduling.
• 4. To accelerate the activities of the project.
• 5. To control the performance of the project.
• 6. The project manager collects financial resources and the
resources of the basis of scheduling.
• 7. To help to reduce the cost
• 8. On the basis of scheduling, project manager measures the
performance of the project and also rectifies the project/job if
necessary.
• Q-3. Methods of project scheduling:
• There are many method of project scheduling. Generally two
methods are used in project scheduling. Those are
• a) Bar chart
• b) Network technique.
• Bar chart: Bar chart is an ancient method of scheduling at the
time of First World War, this method was introduced. It is a
chart where all activities of the project are presented with their
starting and ending time of the project. In the bar chart, left side
of the bar shows stating time and right side shows finishing
• time of a jobs. Length of bar indicates the duration of the job.
•
• Advantages:
• 1. Bar chart reflects acts the true view of a project. By using bar
chart we can know the idea of the project at a glance.
• 2. It is easy to prepare and use. For preparing bar chart no
special training is required,
• 3. By this chart, it is possible to show the actual growth of the
project.
• 4. Through the help of bar chart the manpower of the project
can be presented.
•
• Disadvantages:
• 1. By using bar chart, it fails show the mutual relationship of the
project's Work.
• 2. It has limitation of size. It creates problem in case of large
project scheduling.
• 3. It is difficult to adjust additional cost and time with bar chart.
• Network technique: Network technique has originated to
overcome the hindrance of bar chart in case of presenting of
schedule. It is modern and complex technique. In this
technique, various activities of a project, their relationship, time
of performing etc. are reflected in diagram or map.
• Advantages:
• 1. It can be shown the mutual relationship of the project's work.
• 2. It is useful for lager and complex project scheduling
• 3. We can know the critical work of the project by network
diagram
• 4. By using network technique, we can measure the
performance of a project at any
• Time
• 5. Computer is used in case of network technique. For this,
Change can be made at
• Any situation
• Disadvantages:
• 1. The main hindrance of this method is complex. It is complex
to prepare and use than that of bar chart
• 2. lt indicates the mutual relationship among the project's work
but it does not indicate which work to be done.
• 3. It is not suitable for all types of project scheduling.
 PERT (Programed Evaluate Method) vs. CPM (Critical Path Method)

PERT CPM
1. In PERT network technique, it is 1. In CPM network technique, it is
Considered only time elements. Its main considered both timec and cost clement
subject matter is how much time is of a project.
required to compete a project.
2. PERT is established on probability 2. CPM is not established on probability
theory and three formal times are used theory. In this technique, one formal
for every work. In PERT technique, a time is used for work
project calculates the Probability of
finishing within its estimated time.
3. In PERT network technique, there is 3. In CPM, the relationship among time
no chance to speedy the work. It does and cost are shown and there is chance
not show any relationship among time to speedy the work.
and cost chance to speedy the works are
not shown
4. PERT technique is used where risk 4. CPM technique is used where risk
and time uncertainty is more. and uncertainty is low.
5. Generally, It is used in research 5. Generally it is used in constructive
work
6. PERT network diagram is generally 6. CPM net diagram is activity oriented.
event oriented
Thank
You