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Risk and uncertainty in decision making

Risk and uncertainty

Investment appraisal decisions are based on forecasts, which are subject to
uncertainty.

This uncertainty needs to be reflected in the financial evaluation.

 Risk is quantifiable; possible outcomes have associated probabilities and allow
the use of mathematical techniques.

 Uncertainty is unquantifiable, and the outcome cannot be mathematically
modelled. It is difficult to incorporate uncertainty into decision making models.

 Downside risk is bad; Upside risk means that better may be better than
expected.

Illustrations and further practice

Now read the illustration on ‘Risk and uncertainty’ from Chapter 12.

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