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210 Applying simulation to decision problems
NPV ($m)
Probabilities
Extend existing
plant
Replace with new
equipment
−3 tounder−2 0.05 0.00
−2 tounder−1 0.05 0.05
−1 to under 0 0.15 0.15
0tounder 1 0.29 0.26
1tounder 2 0.22 0.21
2tounder 3 0.14 0.18
3tounder 4 0.10 0.10
4tounder 5 0.00 0.05
(a) Compare the two distributions, and stating any necessary
assumptions, determine the option that the management should
choose.
(b) After the above simulations have been carried out a third possible
course of action becomes available. This would involve the
movement of some of the company’s operations to a new site.
A simulation of this option generated the following probability
distribution. Is this option worth considering?
NPV ($m) Probability
−2 tounder−1 0.05
−1 tounder0 0.05
0tounder1 0.40
1tounder2 0.40
2tounder3 0.04
3tounder4 0.03
4tounder5 0.03
(6) A publisher is considering launching a new magazine for women in
the 18–25 years age group. It is thought to be vital to the long-term
success of the magazine that its sales should reach break-even point
within its first year. When asked to make an estimate of the risk of
this target not being achieved, the marketing manager, after some
thought, states that she thinks the risk is only about 1 in 10.
(a) Sketch out the key features of a risk analysis model which might
be appropriate for this estimate and explain how the estimate
would be obtained from the model.