Chapter 12 @Risk - Spreadsheet Modeling & Decision...

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Spreadsheet Modeling A Practical Introduction to Management Science 5 th edition Cliff T. Ragsdale
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Introduction to Simulation Using @RISK Chapter 12
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On Uncertainty and Decision-Making… "Uncertainty is the most difficult thing about decision-making. In the face of uncertainty, some people react with paralysis, or they do exhaustive research to avoid making a decision. The best decision-making happens when the mental environment is focused. …That fined-tuned focus doesn’t leave room for fears and doubts to enter. Doubts knock at the door of our consciousness, but you don't have to have them in for tea and crumpets." -- Timothy Gallwey, author of The Inner Game of Tennis and The Inner Game of Work .
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Introduction to Simulation In many spreadsheets, the value for one or more cells representing independent variables is unknown or uncertain. As a result, there is uncertainty about the value the dependent variable will assume: Y = f (X 1 , X 2 , …, X k ) Simulation can be used to analyze these types of models.
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A random variable is any variable whose value cannot be predicted or set with certainty. Many “input cells” in spreadsheet models are actually random variables. the future cost of raw materials future interest rates future number of employees in a firm expected product demand Decisions made on the basis of uncertain information often involve risk. “Risk” implies the potential for loss.
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Why Analyze Risk? Plugging in expected values for uncertain cells tells us nothing about the variability of the performance measure we base decisions on. Suppose an $1,000 investment is expected to return $10,000 in two years. Would you invest if. .. the outcomes could range from $9,000 to $11,000? the outcomes could range from -$30,000 to $50,000? Alternatives with the same expected value may involve different levels of risk.
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Methods of Risk Analysis Best-Case/Worst-Case Analysis What-if Analysis Simulation
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Best-Case/Worst-Case Analysis Best case - plug in the most optimistic values for each of the uncertain cells. Worst case - plug in the most pessimistic values for each of the uncertain cells. This is easy to do but tells us nothing about the distribution of possible outcomes within the best and worst-case limits.
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Possible Performance Measure Distributions Within a Range worst case best case worst case best case worst case best case worst case best case
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What-If Analysis Plug in different values for the uncertain cells and see what happens. This is easy to do with spreadsheets. Problems: Values may be chosen in a biased way. Hundreds or thousands of scenarios may be
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Chapter 12 @Risk - Spreadsheet Modeling & Decision...

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