Engineering Economics in Canada Chapter 11 Dealing with Uncertainty: Sensitivity Analysis

Engineering Economics in Canada

Chapter 11

Dealing with Uncertainty: Sensitivity Analysis

Copyright © 2006 Pearson Education Canada Inc. 11-2

Sensitivity Analysis Methods

• Sensitivity graphs illustrate the sensitivity of a particular measure (e.g., present worth or annual worth) to changes in the uncertain parameters of a project.

• Break-even analysis can answer such questions as: “What production level is necessary in order for the PW of a project to be greater than zero?” – Break-even analysis can also give insights

into comparisons between projects. • Scenario analysis allows us to look at the impact

of varying several parameters at a time.


11.4 Scenario Analysis

• Scenario analysis is the process of examining the consequences of several possible sets of variables associated with a project.

• Commonly used scenarios are – the “optimistic” (or “best case”) outcome, – the “pessimistic” (or “worst case”) outcome,– the “expected” (or “most likely”) outcome.

• The best- case and worst- case outcomes can capture the range of possible outcomes for a project, or a comparison among projects.


Example 11.4

• Cogenesis (refer to Example 11.1) wishes to do a scenario analysis of their cogeneration problem in order to decide whether the project should be undertaken.

• They have established optimistic, pessimistic, and expected estimates of each of the parameters for their decision problem.

• The three scenarios and the associated estimates are summarized in Table 11.5


Table 11.5


Example 11.4 Observations

• The scenario analysis reveals that – the present worth of the cogeneration plant

will be negative if all parameters take on their worst- case values

– both the expected-case and best-case scenarios lead to positive present worths

• There is some risk that the cogeneration project will have a negative PW if worst-case scenario occurs.

• However, even if the worst-case outcome does occur, the loss is not huge compared with the potential gain in the other two cases.


Scenario Analysis

• The use of scenarios allows an analyst to capture the range of possible outcomes for a project or group of projects.

• Done in combination with sensitivity graphs and break-even analysis, a great deal of information can be obtained regarding the economic viability of a project.


Scenario Analysis

• The one drawback common to each of the three sensitivity analysis methods covered in this chapter is that they do not capture the likelihood that a parameter will take on a certain value or the likelihood that a certain scenario will occur.

• This information can further guide a decision maker and is often crucial to assessing the risk of the worst case outcome.

• Chapter 12 will describe how these concerns are addressed.


Summary

• Introduction• Sensitivity Graphs• Break-Even Analysis

– For a single project– For multiple projects

• Scenario Analysis


Project----Time Table

• Find your group: Mid-October• Select Topic: End of October• Survey finished: End of Nov. 7• Project: November (3 Weeks)• Project Report Due: Final Quiz


Project----What Wei Wants

• You are a college student, show me your ideas• No exams out of university• Do a good job: Knowledge: 20-50%• Teamwork, independent work, management,

public relation, ability to learn>50%• Wei: Put you in nowhere to see your ability• Jump out of this do-the-assignment system


Project----Requirements

• Group: 3-6 Students should be done now• Topic: Practical, means real data, meaningful

topic , should be almost done now• Length: 15 pages-30 printed pages (12pt). • Report: On Time, Original, Clear, teamwork.• Marks: 1 mark to 1 report, one group• No spoon feed: Independent Team work• Report: 25 marks out of 100


Project Topic----What to do

• You studentS find the topic (chat chat chat chat….FEDEX DELL GOGGLE)

• Do what you like, and what you think is meaningful, and connected to your life

• Those who ask me how many equations should be in the report (>10? >=9?) again get 5 marks deduction each time.

• Not necessary a pure economic topic, the area is OPEN, just do with the economic backgrounds in mind, OPEN your choice


Project----Recourse—Be Active!

• Goggle, Library• Canaidan Government Web• Car Dealer, Dollar store owner • Teacher, Unions, Lawyer• Starting business, stopping business • Economics Faculty• Newspaper, TV• Your Parents, Friends• Go beyond the campus!!!!!!!!!

Did you notice?


Quiz 4---When and Where

• Quiz: Tuesday, Nov. 8, 2005 • 11:30 - 12:20 (Quiz: 30 minutes)• Tutorial: Tuesday, Nov. 15, 2005• ELL 168 Group 1 (<95)• (Students with Last Name A-M) • ELL 061 Group 2 (<60)• (Students with Last Name N-Z)


Quiz---Based on Chapter 10, 11

• Important: Wei’s Slides • More Important: Examples in Slides • 1 Formula Sheet is a good idea• 2 Questions for 1800 seconds. • Wei used 754 seconds • Bring: Paper, Pen, Formula Sheet,

Calculator, Student Card • Write: Name, Student No. and Email


Quiz---Contact Info

• Wei Li [email protected]

• Group 1 +Group 2

• CraigTipping [email protected]

• Group 1 (Last Name A-M) ELL 168

• LeYang [email protected]

• Group 2 (Last Name N-Z) ELL 061

• Do not send me Email at 2:00am Nov. 8 for help;• Do not ask for the problems, Wei was a student.

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Engineering Economics in Canada Chapter 11 Dealing with Uncertainty: Sensitivity Analysis