Esprit Rock

Chapter 5 Summary

Chapter 5 Summary: Performance
Relevant monetary flows are the measures for the financial performance analysis of alternatives. So, for selecting an alternative, our first step is to identify these flows carefully. Some of the relevant flow mistakes are allocating fixed costs, ignoring effects elsewhere in the company, including flows of unrelated activities. The second step is to evaluate the performance of an alternative with the help of these flows. If the flows are known with certainty, it’s a direct calculation of the desired measure which makes the decision making easier. But if there are uncertainty in flows, then we should dig deep into analyzing all possible outcomes of the desired measure. Risk profile is a tool used to list all possibilities and their associated probabilities. EMV is the summation of weighted average of possible outcomes * associated probabilities. For alternatives with too many possible outcomes, Bracket-Median and Pearson-Tukey approximation Technique is used to determine the EMV. This EMV is used by the decision makers to quantify and compare the risk involved in selecting an alternative.

Chapter 6 Summary: Risk Management
In a situation of uncertain flows, a decision maker needs the best information possible about an uncertainty to select a better alternative with higher monetary value. EVPI (EMV with perfect information – EMV without perfect information) is the amount a decision maker has to pay in order to gain access to perfect information. EVII (EMV with imperfect information – EMV without information) is the amount a decision maker should not cross this value in order to get the information. So always EVPI is greater than EVII. EVPC (EMV with perfect control – EMV without control) is the amount paid by the decision maker to control what will happen in future rather than simply predicting the outcome. We should always get EVPC ;= EVPI ;= EVII. One caution is that EVPC or EVPI are approximations since we use change in EMV to calculate them and not the entire risk profiles which triggers a decision maker to pay even more than EVPC or EVPI to get control and perfect information. So, with this control and perfect information we can reduce risks in the risk profile and add value and modify the decision model to incorporate the management ideas.

Critical Questions

1) When there are lot of possible outcomes we use either Bracket Median or Pearson-Tukey approximation Technique. In what situation or criteria, we should use either of the two and will there will be huge difference in our calculation when we use either of the two?
2) Generally, company wants perfect details for their decisions so they are more concerned with EVPC value rather than EVPI value. So, what is the impact of EVPI value in a company? I would like to know what type of companies choose EVPC value and EVPI value respectively.