When deciding among options, money is a major consideration
Risk can be brought into the equation through a higher discount rate, or by calculating the risk exposure as follows
Suppose we are thinking about ways of saving money:
|60% x £100,000||=||£60,000|
|10% x £120,000||=||£12,000|
|20% x £80,000||=||£16,000|
|10% x £60,000||=||£ 6,000|
This is less than original £100,000 because of the risk of small savings
Question: You are a manager in a cost-conscious organisation. Which option would you choose?
A. Save £100,000, but 40% probability of losing £10,000
B. Save £60,000, but 10% probability of saving only £1,000
You should produce a decision tree for the above problem
(60% x £100,000) + (40% x -£10,000) = £60,000 - £4,000 = £56,000 saving
(90% x £60,000) + (10% x £1000) = £54,000 + £100 = £54,100 saving
Which would you choose? Why?
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Question: Which option would you choose?
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