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Examples and Categories of Business Risks

Decision Making under Uncertainty. Chapter 12 slide 1. Examples and Categories of Business Risks . 2. Micro (Demand & Cost) e.g. new product, risky R&D. 1. Macro ( + Political ) econ growth, interest rates inflation, exchange rates.

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Examples and Categories of Business Risks

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  1. Decision Making under Uncertainty Chapter 12 slide 1 Examples and Categories of Business Risks 2. Micro (Demand & Cost) e.g. new product, risky R&D 1. Macro ( + Political ) econ growth, interest rates inflation, exchange rates 3. Regulatory/Legal /Litigation political risks, expropriation 4. Competitive market-share battles, price wars, contractual 6. Human, Organizational reputation, corporate scandals Your job disappears in a reorganization 5. Natural Risks weather, natural disasters, Scientific risks

  2. Drill Don’t Drill Wet $600 .4 Dry -$200 .6 12.2 DRILLING FOR OIL Decisions Chance Events and Possible Outcomes 120 120 Probabilities “objective” “frequency-based” “subjective” $0

  3. BioChem $60 Both succeed BioGen $170 Only Biogen succeeds BioChem $20 Simultaneous Development BioGen $170 Only Biochem succeeds Both “fail” Drug Company R&D Decision 12.3 Investment Outcomes BioChem. $10 M $90 or $50 (.7) (.3) BioGen. $20 M $200 or $0 (.2) (.8) Expected  $68 M $20 M Which R&D program has the greater expected ? Biochem 170 .14 What about Simultaneous Development? 170 .06 72.4 $60 .56 $20 .24

  4. BioChem succeeds $60 .7 BioChem “fails” BioGen succeeds $20 $180 .3 .2 Try BioGen BioGen fails .8 48 Pursue BioChem Quit -$20 An R&D Decision (continued) 12.4 What about Sequential Development? Let’s try Biogenetic First then Biochemical. It’s best to resolve the “larger” risk first. 74.4 48

  5. Moderate Strong 10 20 Recession -22 Launch $0 Don’t Launch LAUNCHING A NEW PRODUCT 12.5 5-Year Profits from a promising New Product depend on the strength of the Economy. Strong Economy: $20 M Moderate Economy: $10 M Recession: -$22 M .36 .40 .24 5.92 Likelihoods of these outcomes? 5.92 Decision Tree? Expected Profit?

  6. Success $100 Produce Redesign .6 $100 High Demand High Demand .5 Failure $0 $80 .4 .4 .4 $0 No Restrictions Low Demand Low Demand .5 $10 -$70 $125 Low Cost .6 .6 Do Not Do Not .5 .5 Restrictions $25 .5 High Cost .5 $0 -$30 Quit Redesigning a Supersonic Aircraft 12.6 80 50 80 75 Producing a Movie 38 4 -2 -30 -42

  7. Accept $.45 $.4 Offer Try to Settle Reject .5 $.95 $.9 Offer Accept .5 Reject $1 Court .2 $.6 .5 $0 .3 12.7 SETTLE or GO TO COURT? .45 $.65 $.65 .55 .65 .6 (+.1)

  8. Drill Don’t Drill Utility Scale Wet $600 100 75 50 25 0 .4 Dry -$200 .6 Monetary Values 12.8 A RISK-AVERSE WILDCATTER (100) (0) Assign utility values to monetary outcomes. 40 u($600) = 100, u(-$200) = 0 u($0) = 50 50 The risk-averse wildcatter chooses not to drill. $0 (50) A risk-averse utility curve is concave. -$200 $0 $600

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