Risk and Uncertainty Using Sensitivity Analysis

INTRODUCTION

All businesses make decisions on a daily basis and as businesses grow, the decision making process becomes more complex and voluminous. These decisions comes with a lot of challenges especially when they involve making plans into the future (which may involve expansion of business, buying heavy equipments, introduction of a new product line e.t.c.).

The more plans are made into the future, the more riskier and uncertain it becomes because the future cannot be told for sure.

The focus of this paper therefore, is to look into Risk and Uncertainties in capital investment appraisal and to see how sensitivity analysis can be applied in this situations.

WHAT IS RISK AND UNCERTAINTIES?

Okoye, 1997: 400 opines that risk is where the decision taken has different expected outcomes but the decision maker has facts, or knowledge or experience of the probability of different outcomes manifesting themselves.

Uncertainties can be seen as a decision whose outcome is expected to be more than one but the decision maker has no facts about the possible outcomes and therefore cannot assign probability values to them.

Drury 2008: 272 defines Risk as a situation where there are several possible outcomes and there is relevant past experience to enable statistical evidence to be produced for predicting the possible outcomes. Uncertainty exists where there are several possible outcomes, but there is little previous statistical evidence to enable the possible outcomes to be predicted.

Adeniji, 2004: 526 also says Risk is associated with those situations where we do not know the future outcome of a project but the probabilities of alternative outcomes can be estimated with some degree of confidence through a careful study of past results in similar fields.

Uncertainty occurs where the future outcomes cannot be predicted with any degree of confidence from knowledge of past or existing events, so that no probability estimates are available. As a result, the...