RISK

MANAGEMENT SESION III

DECISION TREE ANALYSIS
MONTE CARLO SIMULATION
GAME THEORY

 EXAMPLE
Project details
Annual output (nos.) = 2,50,000
Expected sales revenue = Rs. 50,00,000/-
Total cost = 42,50,000/-
Fixed costs = Rs. 25,00,000/-
Calculate BEP.
Also calculate the eect on BEP if
The price comes down by 10% per unit.
The xed cost increases to Rs. 30,00,000/-
The variable cost increases by 15%
Determine the project sensi^vity & advise your Client.
DECISION TREE ANALYSIS
 DECISION TREE ANALYSIS
Graphical technique
Analyzing pros & cons of alterna^ve decisions

It is a diagramma^c representa^on of the

logical rela^onship between the dierent
parts of a complex situa^on & possible
outcomes of dierent decisions.
 DECISION TREE ANALYSIS
A decision tree is made up of nodes & branches.
Decision Nodes decision point represented by a
square.
Chance nodes chance point represented by a
circle.
Dierent alterna^ves for the given situa^on emerges
from the decision point.
At each chance point, the dierent possible
outcomes of one of the alterna^ve decisions are
marked.
CASE ILLUSTRATION
 EXPECTED MONETARY VALUE
The eec^veness of any decision can be
measured only in monetary terms.
So, the outcomes of all decisions are
measured in terms of expected monetary
value (EMV).
EMV provides a common base for comparing
the outcomes of dierent decisions and
choosing the one that is found more
advantageous.
 RULES FOR DRAWING DECISION TREE
1. Iden^fy all alterna^ve decisions available at the
ini^al decision point.
2. Iden^fy all possible subsequent decision points.
3. Iden^fy all possible chance points & the likely
outcomes at the chance points.
4. Develop a decision tree diagram showing in
sequence the decision points & the chance
points. Construct the decision tree diagram from
leh to right. Denote decision points by a square
& chance points by a circle.
 RULES FOR DRAWING DECISION TREE
(contd)

5. Aher construc^ng the decision tree, work

backwards (i.e. from right to leh) compu^ng
the EMV of each chance point & each
decision point ^ll the ini^al decision point is
reached.
6. Determine the best alterna^ve at the ini^al
decision point.
EXAMPLE
MONTE CARLO SIMULATION
 MONTE CARLO SIMULATION
It is a code name given by Von Newmann & Ulam
to the technique of solving problems using
random numbers.
Monte Carlo technique can be used to solve a
variety of problems involving stochas^c
situa^ons (a stochas^c situa^on is one where
some or all parameters of the problem are
described by random variables).
Best alterna^ve when a mathema^cal solu^on is
highly complex/ impossible.
 STEPS IN MONTE CARLO TECHNIQUE
1. From the given probability of occurrence of
events, establish cumula^ve probability.
2. Assign tag nos. to the events in such a way that
the tag nos. represent the cumula^ve
probability.
3. Obtain random nos. from a random no. table.
4. Correlate the random nos. with the tag nos.
assigned to the events & iden^fy the value for
the respec^ve events.

CASE ILLUSTRATION

It is observed that the demand for a product
varies in a random fashion. The demand per day
is observed to have the following probability.
Simulate the demand for 30 days using Monte
Carlo simula^on.

Demand per 25 33 42 51
day
Probability 0.15 0.25 0.45 0.15
GAME THEORY
 GAME THEORY

Business rms compete with each other.

Hence, there are conic^ng interests.
The businesses try to achieve their goals by
formula^ng strategies.
Technique developed by Von Newmann &
named as Game theory.
 PROPERTIES OF THE GAME
1. No. of compe^tors are nite.
2. Each player has nite no. of strategies.
3. All players need not have same no. of
strategies.
4. Each player chooses to play a single strategy
out of those available to him. All players are
assumed to make their choice simultaneously.
5. The outcome of the play depends upon the
strategies followed by the players.