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MIT Civil Engineering 1.011 -- Project Evaluation Spring Term 2003Carl D. Martland Page 11.011 Project EvaluationDealing with Risks & UncertaintyCarl D. Martland1. Definitions 2. Techniques3. ExamplesUncertaintyWe cannot predict the future, and we may not even have good estimates of probabilities of possible outcomesVariations about the normChanges in trends"New Facts"Projects create new demands - and we can't always refer to past experienceRisksRisks refer to the possibility that something will go wrong. For example:Construction risks(unable to construct on time and within budget because of technical or organizational problems)Competitive risks (loss of market to better,earlier, or larger projects similar to or substituting for your project) Financial risks (changes in interest rates ,exchange rates, credit limits that affect our ability to raise sufficient funds for project; changes in cash flows that affect ability to mortgage payment)Political risks (changes in government or in regulations that limit our ability to complete, open, or receive payment for our project)Sensitivity AnalysisSystematic analysis of the effects of changes in one or more variable on our results and our choice of an alternativeCost factors: unit costs, discount rates, process speedBenefit factors: prices, demand, external impactsKey choicesWhat is our base case?Best estimate of all factorsWhat factors to vary? by how much?Those with the greatest uncertainty and those related to known risksVary over likely range of optionsScenariosA "scenario" is a set of internally consistent assumptions that together provide a vision of a "possible" future within which our project will be implementedBroader than sensitvity analysisFor example: Optimistic/Most Likely/PessimisticElements of a Scenario - the factors that we believe are important to our project that we wil vary across scenarios. For example:General economic conditionsResponse of competitors to our projectConstruction prices"Make Uncertainty Explicit"Understand the uncertainties and the risksSensitivity analysisScenario analysisSeek protection against the most serious riskUse discount rates that are suitable for the risks evident for a particular project Higher return for riskier projectsMIT Civil Engineering 1.011 -- Project Evaluation Spring Term 2003Carl D. Martland Page 2Protection Against Most Serious RisksFailure to meet budget & time tableStudies, site surveysPenalty clauses in subcontracts"Cost Plus" rather than "Fixed Price" contractFailure to meet revenue targetsStudies and surveysPricing & staging optionsNatural disaster; construction accidentsInsuranceSafety plan - WHEN to work; HOW to workBankruptcyMinimal leveraging; loan guarantees Government interferencePartnerships with government or local firmsRisks Are Shared Among the Actors Involved in a ProjectAre MY risks commensurate with MY potential benefitsCan I include sufficient time in the work schedule to cover the expected range of delays and a sufficient amount in my budget to cover the expected range of cost variation?Can I get insurance to limit my liability for the worst things that might occur?Can I negotiate a better deal?Bidding on a Project:Include a "Margin of Error"Exp. CostExp. Cost + FeeCover with Insurance80828486889092969810010210410610811011211411611812012212412612813005101520253035StagingBreak the project into several stages that can be implemented if and when demand warrantsMay lead to higher construction consts for the project if all stages are eventually buildAdded flexibility reduces risks that insufficient demand will lead to financial problemsExamplesBuild one tower where there is room for twoBuy options for additional landBuild a house, but don't finish the basement or the atticProbabilistic Risk AssessmentProblem: how to deal with risks related to natural disasters or unusual events (earthquakes, fires, accidents)Assess risksProbability of event (PROB)Expected consequences of event (CON)Assess cost C of reducing risks Compare incremental cost to incremental riskIf C < PROB(new)*CON(new), then it is worth adding the extra costThere may be many effective ways of reducing risksPublic RoleLoan guaranteesReduce interest rates for private sectorPartnershipsEase burden of dealing with regulationsContract for services (e.g. for commuter rail)Contractor provides service; agency absorbs risks related to demand and revenuesExclusive franchises (e.g. for highway)Limit


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MIT 1 011 - Dealing with Risks and Uncertainty

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