Chapter 15 - Decisions under risk and uncertainty. When managers make choices or decisions under risk or uncertainty, they must somehow incorporate this risk into their decision-making process. This chapter presented some basic rules for managers to help them make decisions under conditions of risk and uncertainty. | Chapter 15 Decisions Under Risk and Uncertainty Risk vs. Uncertainty Risk Must make a decision for which the outcome is not known with certainty Can list all possible outcomes & assign probabilities to the outcomes Uncertainty Cannot list all possible outcomes Cannot assign probabilities to the outcomes 15- Measuring Risk with Probability Distributions Table or graph showing all possible outcomes/payoffs for a decision & the probability each outcome will occur To measure risk associated with a decision Examine statistical characteristics of the probability distribution of outcomes for the decision 15- Probability Distribution for Sales (Figure ) 15- Expected Value Expected value (or mean) of a probability distribution is: Where Xi is the ith outcome of a decision, pi is the probability of the ith outcome, and n is the total number of possible outcomes 15- Expected Value Does not give actual value of the random outcome Indicates “average” value of the outcomes if . | Chapter 15 Decisions Under Risk and Uncertainty Risk vs. Uncertainty Risk Must make a decision for which the outcome is not known with certainty Can list all possible outcomes & assign probabilities to the outcomes Uncertainty Cannot list all possible outcomes Cannot assign probabilities to the outcomes 15- Measuring Risk with Probability Distributions Table or graph showing all possible outcomes/payoffs for a decision & the probability each outcome will occur To measure risk associated with a decision Examine statistical characteristics of the probability distribution of outcomes for the decision 15- Probability Distribution for Sales (Figure ) 15- Expected Value Expected value (or mean) of a probability distribution is: Where Xi is the ith outcome of a decision, pi is the probability of the ith outcome, and n is the total number of possible outcomes 15- Expected Value Does not give actual value of the random outcome Indicates “average” value of the outcomes if the risky decision were to be repeated a large number of times 15- Variance Variance is a measure of absolute risk Measures dispersion of the outcomes about the mean or expected outcome The higher the variance, the greater the risk associated with a probability distribution 15- Identical Means but Different Variances (Figure ) 15- Standard Deviation Standard deviation is the square root of the variance The higher the standard deviation, the greater the risk 15- Probability Distributions with Different Variances (Figure ) 15- Coefficient of Variation When expected values of outcomes differ substantially, managers should measure riskiness of a decision relative to its expected value using the coefficient of variation A measure of relative risk 15- Decisions Under Risk No single decision rule guarantees profits will actually be maximized Decision rules do not eliminate risk Provide a method to systematically include risk in the decision making process 15-
