Ajjan Associates, LLC

How can you mathematically evaluate risks of new investments?

Uncertainty is all around us, especially in business. There is no such thing as a risk-free investment. However, there are ways to better understand and quantify risk in order to make more informed decisions with a greater likelihood of profitability.

Our risk analysis modeling techniques enable complex estimations of expected results to better understand the uncertainty associated with any business decision. Quite simply, knowledge of risk increases confidence in an investment.

Our techniques quantify risk using a tool called Decision Tree Analysis.

Often, the results predicted by Decision Tree Analysis expose severe risks that will most likely make an investment unprofitable.

Above: Decision Tree from a sample risk analysis project executed by Ajjan Associates. Read more to learn how your company can make use of this powerful method.

more services from Ajjan Associates:

Conjoint Analysis - Resource Allocation - Decision Calculus

Eligibility for Decision Trees

Eligibility for the risk analysis model requires a step-by-step listing of every possible decision or outcome associated with an investment being considered, and an estimated guess of what might happen in each case.

For example, if you are building a residential or commercial unit for resale, you will need to list each and every possible outcome, including all of the legal processes, potential changes in material or labor costs, expected sell price, etc.

Decision Tree Method

Let's use the example of a winery. Assume that you have a crop of grapes, and you must decide when to harvest. Many factors will affect the quality of your crop, including the temperature, the amount of rain, etc.

The first thing we will ask you to do is to list each and every possible "fork in the road" in chronological order. Sometimes, a decision point will have 2 possible outcomes, sometimes 3, occasionally more.

harvest early or late? (this is the critical decision we need to assess)
invest in new weather prediction equipment? (has a high cost, but could help to determine whether heavy rains are expected, lowering the quality of the crop and bringing less revenue)
buy special fertilizer to lower acidity? (expensive investment, but could increase the likelihood of a low-acidity product which will sell for a higher value on the market)
expected cost per case? (given negotiations and volume differences, some clients will pay more than others, and we should estimate the selling price at high, medium, and low levels)

Now we take all of this data and put into into a "tree" as shown below:

At each point, as shown on the Decision Tree above, the probability of each outcomes is listed, along with the impact on the revenue or profit for each decision point.

Decision Tree Results

Now the software comes in. It will take the entire Decision Tree, and calculate the overall expected outcome of the investment being considered, using the predictions and estimates we entered. Ultimately, all of the probabilities are converted to dollar values, and the crucial decision is given a number corresponding to the expected revenue or profit that will result. Quite simply, we pick the decision with the higher number.

As you can see, this is a robust, quantitative method. Once the model is designed, you can easily conduct a sensitivity analysis to evaluate worst case scenarios (e.g. if your negotiations go poorly and the cost per case decreases). The expandability and flexibility makes this a powerful model.

Please fill out the form to the right to learn more about the design and implementation of this powerful technique.

We would be more than happy to schedule an initial consultation free of charge to understand how our risk analysis tools can help you, either by phone or in person.

PO Box 4031 - Clifton, NJ 07012 USA

george@ajjan.com - +1 (973) 685-6368

Conjoint Analysis - Risk Analysis - Decision Calculus - Resource Allocation

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