6.1 Introduction
Until this point in the book we have all but ignored questions of risk. We are now
going to start to confront the issue, and though this is the only chapter with the word
‘risk’ in its title, much of the remainder of the book is concerned with problems
of making decisions about a future in which we just do not know what is going to
happen. Some events we can predict fairly confidently (for example, the population
of the UK in five years’ time, give or take a million). Other matters (such as how many
of that population will buy our business’s product) are rather more difficult to predict.
None of the input data for decisions is known with absolute certainty, so risk is a
constant problem for decision makers.
Despite this awkward environment, decisions must still be made. Delaying
decisions until the mist of doubt lifts will not be a very fruitful approach, since it never
will lift. In the context of a particular decision, it might be that delay may remove
Risk in investment appraisal
In this chapter we shall deal with the following:
‘the importance of risk and of its formal consideration in the decision-making
process
‘the use of sensitivity analysis to try to assess the riskiness of a particular
project
‘the use of statistical probabilities to try to assess risk
‘expected value and its deficiencies in the treatment of risk
6.5 Systematic and specific risk
‘utility theory
‘risk aversion
6.9 Some evidence on risk analysis in practice
Chapter 6