Computer Simulation in Financial Risk Management: A Guide for Business Planners and Strategists

By Roy L. Nersesian | Go to book overview

2
A Businessman's Assessments

The perception of risk and reward is the result of a businessman's thought processes. Let us say that the businessman speculates that a new factory will be able to produce V volume of goods that can be sold for P price. The question is: Where do V and P come from? Some say that V and P spring from the imagination while others maintain that V and P are a result of a deliberate cognitive process of logic and dispassionate judgment. Perhaps these, and other conjectures concerning the thought process of the human mind, are all part of a businessman's assessments of the projected values of price and volume. These values, when properly manipulated with costs, provide the businessman with an estimate of the profitability of an investment. This is the quantification of reward.

The quantification of risk entails obtaining additional assessments from a manager. Reward is based on the most likely assessment of outcomes. Risk requires assessing the least likely outcomes--not just the worst outcome, but also the best. This should not be too much of a burden to place on the mental shoulders of a manager who must assess the most likely of outcomes. When a manager is attempting to assess the most likely, high volumes and equally high prices and low volumes and equally low prices come to mind.

Suppose that a manager has assessed the reward of a proposal to build a new factory on the basis of a volume of sales of 500 units per year (bearing in mind that a unit may represent hundreds or thousands of an individual item). This volume is the most likely assessment of what sales will be for the purpose of calculating profit over the twenty-year life of the factory. This assessment of sales of 500 units does not mean that the manager expects the factory to produce, and sell, 500 units without any variation over the next twenty years. Nor does the manager expect that the price used to calculate reward will also remain un

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