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:

- most likely that a given action will save £100k
- 10% chance it will save more, i.e. £120k
- 20% chance it will save only £80k
- 10% chance it will save only £60k

60% x £100,000 | = | £60,000 |

10% x £120,000 | = | £12,000 |

20% x £80,000 | = | £16,000 |

10% x £60,000 | = | £ 6,000 |

Factored cost | = | £94,000 |

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?

(Move your mouse pointer over the icon for a suggestion)

**Question:** Which option would you choose?

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