SLIDE 1
1
CIMA Paper P2 Advanced Management Accounting Ian Kusano and Nathi - - PowerPoint PPT Presentation
CIMA Paper P2 Advanced Management Accounting Ian Kusano and Nathi - - PowerPoint PPT Presentation
CIMA Paper P2 Advanced Management Accounting Ian Kusano and Nathi Thela 12 Chapter Uncertainty and risk in decision making 1 Uncertainty and Risk Investment appraisal faces the following problems: all decisions are based on forecasts
SLIDE 2
SLIDE 3
2
Uncertainty and Risk
Investment appraisal faces the following problems:
- all decisions are based on forecasts
- all forecasts are subject to uncertainty
- this uncertainty needs to be reflected in the financial evaluation.
The decision maker must distinguish between:
risk – quantifiable – possible outcomes have associated probabilities, thus allowing the use of mathematical techniques uncertainty – unquantifiable – outcomes cannot be mathematically modelled.
SLIDE 4
3
Uncertainty and risk
Risk Uncertainty
- Past experience
– Probabilities
- No experience
– No probabilities Several Possible Outcomes
SLIDE 5
4
Expected Values
EV = ∑px
Long run weighted average Probability of the outcome occurring Future outcome Sum of
SLIDE 6
5
Expected Value Example 1
An organisation is considering launching a new product. It will do so if the expected value of the total revenue is in excess of $1,000. It is decided to set the selling price at $10. After some investigation a number of probabilities for different levels of sales revenue are predicted; these are shown in the following table: Units sold Revenue ($) Probability Pay-off ($) 80 800 0.15 120 100 1,000 0.50 500 120 1,200 0.35 420 1.0 EV = 1,040 In preparing forecasts and making decisions management may proceed on the assumption that it can expect sales revenue of $1,040 if it sets a selling price of $10 per unit. The actual
- utcome of adopting this selling price may be sales revenue that is higher or lower than
$1,040. And $1,040 is not even the most likely outcome; the most likely outcome is $1,000, since this has the highest probability.
SLIDE 7
6
Expected Value Example 2
A company has identified four possible outcomes from a new marketing strategy as follows: Outcome Profits ($) Probabilities A 100,000 0.10 B 70,000 0.40 C 50,000 0.30 D
- 20,000
0.20 1.00 Calculate the expected outcome of this strategy.
SLIDE 8
7
Expected Value – November 2013
SLIDE 9
8
Expected Value – November 2013
SLIDE 10
9
Decision Making Criteria and Risk Attitudes
Maximax
- Best
possible
- utcome
- Choose
the best of the best Risk Seeker Maximin
- Worst
possible
- utcome
- Choose
the best of the worst Risk Averse Expected Value
- Weighted
average profit
- Choose the
highest expected value Risk Neutral
SLIDE 11
10
Perfect and Imperfect Information
- Always 100% accurate
Perfect Information
- Usually correct
Imperfect Information Both have a value! Value of information = expected profit WITH information – expected profit WITHOUT information Illustration 7.
SLIDE 12
11
Perfect Information September 2013 Exam
SLIDE 13
12
Decision Trees and Multi-Stage Decision Problems
1. Draw tree from left to right, showing decision and
- utcomes:
- Label tree
- Show cash inflows/outflows
- Probabilities
2. Evaluate tree from right to left:
- Outcome point – calculate EV
- Decision point – choose best option