Uncertainty in Future EventsChapter 10: Newnan, Eschenbach, and LavelleDr. Hurley’s AGB 555 Course

Ways Of Dealing with Uncertain Events• Range of Estimates• Look at what the metrics (e.g., PW) are for an optimistic estimate,

a most likely estimate, and a pessimistic estimate• You could calculate the metric used in project management

• (Optimistic Value + 4*Most likely Value + Pessimistic Value)/6

• Calculate Expected Values• Expected value is the sum of the outcomes multiplied by their

probabilities• Economic Decision Trees• These represent more complex investments that may or may not

have a probabilistic nature to them and potentially multiple decisions need to be made

Economic Decision Trees• In economic decision trees, you have three main components:• A decision node ( )where you get to make some decision out of

a set of possibilities• A chance node ( ) where multiple outcomes can occur each

with their own probability• An outcome node ( )is the result of a set of decisions and

chance outcomes• In class we will discuss problem 10-40 from the textbook

Risk• One definition of risk is the chance of getting an outcome that

is different then the expected value• One measure of risk is the probability of a getting a loss• Another measure of risk is the standard deviation (σ)

• One way of understanding risk is to use a risk and return graph• This plots return with its corresponding risk

Simulation• This method uses random sampling from a probability

distribution• It makes many draws from the sample and calculates a metric for

the draws, e.g., IRR, PW, EUAC, etc.• Useful Excel tools for doing simulations• Under Data Analysis, there is a random number generator• Using the Rand() function with the Norm.Inv() function will draw

a random value from the normal distribution• RandBetween() will draw from a uniform distribution