Group 2 Weekend (Project management &

finance)
Tewodros Mengesha
Kidus Dagnaw
Derartu Adugna
Habtu Surra
Misgana Assefa
Nuredin Petros
1.Explain the types of perspectives of project
risk and their difference.

2.Briefly explain the techniques of sensitivity

and break even analysis of risk using numeric
illustration
 Types of perspectives of project risk and their
difference.
Introduction
The word “risk” in English derives from its Latin root word
risicare, which means “to dare”, which implies the
possibility to choose a course of action (Bernstein, 1998).
There are many definitions of the concept of risk in the
literature; some are related to some aspect of risk, others
with some category of risk. Traditionally, risk definitions
only focus on the negative impact of events, discarding
the beneficial effect that uncertainty can have on
achieving objectives.
In other hand, Project management is about making
decisions under uncertainty, throughout the various
phases of a project. Different perspectives on risk
can be held by project management, and these
perspectives can appear inconsistent and even in
conflict.

There are mainly 2 kinds of perspectives that have

sub categories under each perspectives
 Functional perspectives: this includes
Financial risks :
Market Risk: risks that potentiate loss due to adverse
changes in some financial market variables;
Credit Risk: risks that potentiate loss due to a
counterpart failing to make payment;
Operational Risk: risks that potentiate loss originated
by human errors, system failures or inadequate
procedures or controls;
Liquidity risk: risks related with the ease with
which a corporation can convert an asset into a cash
amount equal to its current market value.
 Through the use of financial instruments, financial
risk management deals with the time and form
of hedging risk exposures. As a financial
instrument, derivate play an important role in
financial risk management. The main types of
derivate are forward contracts, future contracts,
options and swaps.
 Insurance risk:
"the practice of identifying and analyzing loss
exposure and taking steps to minimize the
financial impact of the risk they impose".
Insurance risk management focuses primarily on
pure risks, i.e., those risks that only involve
potential loss. This term has distinguished between
the traditional risk management concept and the
more recent approaches to risk management.
The types of risks that are associated with pure
risks by companies are
 Property risks: related to the damage of physical
property, loss or theft resulting from various
hazards;
 Liability risks: risk of hurting a third party and
being held liable for bodily injury or other damages;
 Loss of potential income risk: potential income
loss by a company whose operations have been
interrupted;
 Other risks: Additional risks include crime
exposure, human resources exposure, foreign loss
exposure, intangible property exposure and
government exposure.
Information technology risk
The information systems risk management view of
risk is more recent and results from the
information and technological evolution as well as
the importance that IT holds today in most
businesses. The information systems risk
management is "the process of understanding and
responding to factors that may lead to a failure in the
confidentiality, integrity or availability of an
information system".
The risks as:
Security risks: risks that result from internal or
external unauthorized access to information;
Availability risks: risks that information might not
be accessible due to unplanned system failures;
Performance risks: risks related to inaccessible
information as result of scalability limitations
or throughput bottlenecks;
Compliance risks: risks of failure to meet
regulatory requirements or failure to meet
internal policy requirements.
Information systems risk management is not just a
technical issue. Enterprises must understand the
growing number of IT risks in an environment
that results from the combination of users, new
technologies and the spread of sensitive data.
 Process oriented perspectives
Supply chain risk
Classification of risks based on the nature of the
uncertainty source in relation to the network. There
are two types of uncertainty sources:
Internal sources
Available capacity - relates to the networks
financial, productive and structural availability for a
project;
Customs regulations - reflects the risk of exposure
to regulations;
Information delays - reflects the risk of not having the information
available in the moment in time that it is needed;
Internal organization - risk of noncooperation in the supply
chain or inability to adopt new technology.
external sources
Competitor action - risks that derive from the loss of competitive
advantage;
Manufacturing yield - risk of demand not meeting the product
consumption forecasts;
Political environment - risk that results from contextual change
and unforeseeable regulatory action;
Price fluctuations - risk of not being able to cover the networks
costs due to price fluctuations;
Stochastic cost - risk that results from the product becoming
obsolete;
Supplier quality - risk of inability to supply specific skills.
Supply Chain Risk Management has
been recognized as an important source
of competitive advantage and is
becoming an integral part of Supply
Chain Management as an effective
method of avoiding or containing
vulnerability in a supply chain
 Business process risk
From a business process risk management
perspective, the error type and the consequence do
not have a direct one-to-one relation. zur Muehlen
and Ho (2006) propose the following classification
of risks which is supported by the business process
life cycle:
Build time risks: related with the design phase of a
business process;
Goal risks: risk that threatens the possibility of the
business process achieving the expected objectives;
Structural risks: related with the design phase of a
business process structure;
Run time risks: related to process disruption, these
risks threaten internal components of the business
process structure preventing them from performing
as designed.
The business process life cycle plays an
important role on the integration of a business
process with risk management, since the different
stages of the business process lifecycle pose
different challenges for risk integration (zur
Muehlen & Ho, 2006).
 Enterprise risk
Enterprise risk management approach also provides a
taxonomy for different risks. Considering the various
nature of risks companies are exposed to, Grey and
Shi (2005) consider that there are two main types of
enterprise risks:
• core business risks: risks that impact into the company's
core business activities;
• Operational risk: Related with the way a company
operates the business. It includes factors as human error,
fraud or technical failures;
• Value chain risk: Related with the goods and services
delivered to the costumers. It is caused by key business
drivers like fluctuations of the price of goods or quantity
changes.
• Non-core business risks: risks that affect the
support activities of the company, depending
on the frequency of the risk event. Can be
divided into:
• Event risks: include legal risk, natural
hazard, political risk, regulatory risk,
economic and reputational risk;
 Techniques of sensitivity and break even analysis of risk using
numeric illustration
The technique used to determine how independent variable values
will impact a particular dependent variable under a given set of
assumptions is defined as sensitive analysis. Its usage will depend on
one or more input variables within the specific boundaries, such as
the effect that changes in interest rates will have on a bond’s price.
It is also known as the what – if analysis. Sensitivity analysis can be
used for any activity or system. All from planning a family vacation
with the variables in mind to the decisions at corporate levels can be
done through sensitivity analysis.
It helps in analyzing how sensitive the output is, by the changes in
one input while keeping the other inputs constant.
Sensitivity analysis works on the simple principle: Change the model
and observe the behavior.
Sensitivity analysis can be used to determine the
following:
Similarity of the model with the observed process,
Quality of the model definition,
Factors contributing the most to output variables,
Areas in the input factor space for which there is
maximum variation,
Optimum area in the space of factors, which are
used in subsequent exploration of adjustments,
Interaction between factors.
 Measurement of sensitivity analysis
1.Below are mentioned the steps used to conduct sensitivity analysis:

2.Firstly the base case output is defined; say the NPV at a particular
base case input value (V1) for which the sensitivity is to be measured.
All the other inputs of the model are kept constant.

3.Then the value of the output at a new value of the input (V2) while
keeping other inputs constant is calculated.

4.Find the percentage change in the output and the percentage change in
the input.

5.The sensitivity is calculated by dividing the percentage change in

output by the percentage change in input.
This process of testing sensitivity for another
input (say cash flows growth rate) while keeping
the rest of inputs constant is repeated till the
sensitivity figure for each of the inputs is
obtained. The conclusion would be that the
higher the sensitivity figure, the more sensitive
the output is to any change in that input and vice
versa.
 Methods of Sensitivity Analysis

There are different methods to carry out the

sensitivity analysis:
Modeling and simulation techniques
Scenario management tools through Microsoft
excel
There are mainly two approaches to analyzing
sensitivity:
Local Sensitivity Analysis
Global Sensitivity Analysis
Local sensitivity analysis is derivative based (numerical or
analytical). The term local indicates that the derivatives are
taken at a single point. This method is apt for simple cost
functions, but not feasible for complex models, like models
with discontinuities do not always have derivatives.
Mathematically, the sensitivity of the cost function with
respect to certain parameters is equal to the partial derivative
of the cost function with respect to those parameters.
Local sensitivity analysis is a one-at-a-time (OAT) technique
that analyzes the impact of one parameter on the cost
function at a time, keeping the other parameters fixed.
Global sensitivity analysis is the second approach to
sensitivity analysis, often implemented using Monte Carlo
techniques. This approach uses a global set of samples to
explore the design space.
• The various techniques widely applied include:
• Differential sensitivity analysis: It is also referred to the
direct method. It involves solving simple partial derivatives
to temporal sensitivity analysis. Although this method is
computationally efficient, solving equations is intensive task
to handle.
• One at a time sensitivity measures: It is the most
fundamental method with partial differentiation, in which
varying parameters values are taken one at a time. It is also
called as local analysis as it is an indicator only for the
addressed point estimates and not the entire distribution.
• Factorial Analysis: It involves the selection of given number
of samples for a specific parameter and then running the
model for the combinations. The outcome is then used to
carry out parameter sensitivity.
Through the sensitivity index one can calculate
the output % difference when one input parameter
varies from minimum to maximum value.
• Correlation analysis helps in defining the
relation between independent and dependent
variables.
• Regression analysis is a comprehensive method
used to get responses for complex models.
• Subjective sensitivity analysis: In this method
the individual parameters are analyzed. This is a
subjective method, simple, qualitative and an
easy method to rule out input parameters.
 Uses of Sensitivity Analysis
The key application of sensitivity analysis is to indicate the
sensitivity of simulation to uncertainties in the input values
of the model.
They help in decision making
Sensitivity analysis is a method for predicting the outcome
of a decision if a situation turns out to be different compared
to the key predictions.
Helps in identifying how dependent the output is on a
particular input value. Analyses if the dependency in turn
helps in assessing the risk associated.
Helps in taking informed and appropriate decisions
Aids searching for errors in the model
 SENSITIVITY ANALYSIS
A Sensitivity Analysis is a "what-if" tool that
examines the effect on a company's Net Income
(bottom line) when sales levels are increased or
decreased. For example, the sensitivity analysis
can answer the following questions:
"WHAT" would be my forecasted net income,
"IF" my sales forecast is 30%, 20%, or 10% too
high?
"WHAT" would be my forecasted net income,
"IF" my sales forecast is 30%, 20% or 10% too
low?
In other words
1. What would my bottom line be if I sold 10% more units
than I originally forecasted?
2. What would my bottom line be if I sold 20% more units
than I originally forecasted?
3. What would my bottom line be if I sold 30% more units
than I originally forecasted?
4. What would my bottom line be if I sold 10% fewer units
than I originally forecasted?
5. What would my bottom line be if I sold 20% fewer units
than I originally forecasted?
6. What would my bottom line be if I sold 30% fewer units
than I originally forecasted?
Below provides an example of a sensitivity analysis.
RESUME SERVICES
FORECASTED SENSITIVITY ANALYSIS
FOR YEAR ENDING DECEMBER 31, 200X

15% Decline 10% Decline 200X Original 10% Incline

in Sales in Sales Forecasted in Sales
Figures

Sales $88,400 $93,600 $104,000 $114,400

Cost of Goods Sold $10,200 $10,800 $ 12,000 $ 13,200
GROSS PROFIT $78,200 $82,800 $ 92,000 $101,200

OPERATING EXPENSES:
Marketing Expenses:
Promotional Pamphlet $ 4,000 $4,000 $4,000 $ 4,000
Expense

University Advertising $ 8,000 $8,000 $8,000 $ 8,000

Expense

Newspaper Advertising $25,998 $25,998 $25,998 $25,998

Expense

Total Marketing Expenses $37,998 $37,998 $37,998 $37,998

Administrative Expenses:
Office Salaries Expense $15,600 $15,600 $15,600 $15,600
Employer Costs (11% of $1,716 $1,716 $1,716 $1,716
Salary)
Office Supplies Expense $2,500 $2,500 $2,500 $2,500
Business Cards, etc. Expense $ 250 $ 250 $ 250 $ 250

Printing of Checks Expense $ 75 $ 75 $ 75 $ 75

Telephone Expense $1,200 $1,200 $1,200 $1,200

Business Registration Expense $1,200 $1,200 $1,200 $1,200

Message Centre Expense $4,600 $4,600 $4,600 $4,600

Toll Free Services Expense $9,600 $9,600 $9,600 $9,600

Credit Card Service Expense $4,992 $4,992 $4,992 $4,922

Bank Charges Expense $ 240 $ 240 $ 240 $ 240

Miscellaneous Expenses $1,800 $1,800 $1,800 $1,800
Depreciation Expense, Auto $1,000 $1,000 $1,000 $1,000

Depreciation Expense, $1,400 $1,400 $1,400 $1,400

Equipment

Total Administrative Expenses $46,173 $46,173 $46,173 $46,173

TOTAL OPERATING EXPENSES $84,171 $84,171 $84,171 $84,171

INCOME BEFORE TAXES $(5,971) $(1,371) $7,829 $17,029

A sensitivity analysis consists of three main
components namely; 1) The Heading, 2) Sales
Percentage Factors, and 3) The Body. Below briefly
explains each component; beginning with The
Heading.
 STEPS TO DEVELOP A SENSITIVITY ANALYSIS ARE
SUMMARIZED BELOW
 develop your forecasted income statement;
 set your sales percentage factors (10%, 20%, and 30%
for instance); look at each cost & expense and
determine which is a variable cost and which is a fixed
cost;
 Increase & decrease the sales in dollars at the various
sales percentage (%) factors;
 Increase & decrease the variable costs at the various
sales percentage (%) factors;
 The fixed costs will remain the same at various sales
increases & decreases;
 Subtract each column's variable costs and fixed
costs from each sales column to arrive at the net
income before tax at the various sales increases &
decreases;
 Apply a tax rate to the net income before taxes to
arrive at the Net Income After Taxes (optional).
Break-Even Analysis
Break-even analysis is a widely used technique in
project management. Break-even is a no profit and no
loss situation for a project. In break-even analysis, all
costs associated with a project are divided into two
heads, fixed costs and variable costs.
The total fixed cost and the total variable cost are then
compared with the total return or revenue of the
project. In a break­even scenario, the total of all fixed
costs or variable costs in a project is equal to the total
revenue or return from the project. Therefore, a
project can be said to have reached its break-even
when it does not have any profit or loss.
 Conclusion
Sensitivity analysis is one of the tools that help
decision makers with more than a solution to a
problem. It provides an appropriate insight into the
problems associated with the model under
reference. Finally the decision maker gets a decent
idea about how sensitive is the optimum solution
chosen by him to any changes in the input values
of one or more parameters.