BSV11105 Project Risk Management

Examination Diet 2019/20 Trimester 2 COVID
MODULE CODE: BSV11105
MODULE TITLE : Project Risk Management
EXAMINER’S NAME: Alastair Stupart
EXAM DURATION: 7 CALENDAR DAYS
EXAM PAPER INFORMATION
Total number of pages (including coversheet): NINE
Number of Questions: SIX
INSTRUCTIONS TO CANDIDATES (PLEASE READ CAREFULLY)
You must answer ALL questions. An indicative word count of 1000 words per
question is also set for the Exam (excluding; for example; any sketches, drawings,
diagrams, formulae, or calculations).
SPECIAL INSTRUCTIONS (BSV Module Codes)
Please use Microsoft Word to type your answers. Where you need to produce any
sketches, drawings, diagrams, formulae, or calculations to support your answers,
please make sure they are inserted into the document. Please also remember to
put the module number and your matriculation number at the beginning and save
your work at regular intervals.
You must ensure that all questions and pages are clearly numbered.
When you have answered all the questions, upload the document to Moodle as one
single file. Instructions on how to do this can be found in the Moodle Exam
Instructions. Please ensure you do this in sufficient time and prior to the stated
deadline, so as to avoid any technical issues. You should also retain a hard and soft
copy of your answer script in case of queries. Please be aware that examination
answer scripts may be subject to plagiarism checks.
SPECIAL ITEMS INCLUDED AT THE END OF THE QUESTION PAPER: Present
Value Table, Annuity Table, Standard Value Table
2
Question 1

(a)Discuss some of the general rules for the good practice handling of risks in
business and/or construction contracts. Your answer should make specific reference
to (i) lump sum (i.e. fixed price) contracts and (ii) the concept of unforeseen site
conditions.(12 marks)

(b) A marketing agency adds a “mark-up” of 10 % on each job (this is to
cover such as: risk, overheads, changes in the economy). An audit of the
agency’s operations is shown in Table 1.
Table 1
(i) Determine the expected profit on any given job. (5 marks)
(ii) The managing director decides that recruiting additional experienced business
development staff will improve the agency’s probabilities of making a profit.
Having made these changes, the probabilities are as Table 2.
Table 2

Percentage profit/lossPercentage of jobs
(probability)
25% profit4
20% profit6
15% profit20
10% profit30
5% profit30
Break even5
10% loss5
15% loss0

If the annual contract volume of the firm is $200m, determine the additional
expenditure that the agency could spend on new staff and still make the profit
that they previously achieved.
(8 marks)
Total [25] marks

Percentage profit/lossPercentage of jobs
(probability)
25% profit0
20% profit5
15% profit15
10% profit25
5% profit30
Break even10
10% loss10
15% loss5

3
Question 2
(a) Choose three of the reasons given in the module as to why companies should
manage Health & Safety related risks. For each of the three, provide more details.
(9 marks)

(b)A project requires an immediate cash input of €4.0 million in return
for the estimated cash flows (Table 3).

Table 3

State of the economyProbabilityEnd of year 1
(€ million)
End of year 2
(€ million)
Recession0.21.01.5
Growth0.33.03.5
Expanding0.55.05.5

Assume that the state of the economy will be same in the second year as in
the first. The risk-adjusted discount rate is 10%. Calculate the following:
(i) The expected Net Present Value (NPV). (4 marks)
(ii) The standard deviation of NPV. (4 marks)
(iii) The probability of NPV being less than zero assuming a normal
distribution of return. (4 marks)
(iv) Interpret the figure calculated in (iii). (4 marks)
Total [25] marks
4
Question 3
(a) Discuss (making reference to the Allais Paradox) why expected utility may be
a true reflection of the way people decide on gambles; rather than expected
monetary value. (6 marks)
(b) A building contractor is providing an estimate to a potential client for carrying
out a construction project. The contractor views that if they offer to undertake
the work for £150k there is a 0.2 probability that the potential client will agree
to the price; a 0.5 probability that a price of £100k would be agreed; and a 0.3
probability that the potential client will reject the offer.
If the contractor offers to undertake the work for £100k they anticipate, there
is 0.3 probability that the potential client will accept the price; a 0.6 probability
that the potential client will negotiate so that a price of £80k will be agreed;
and a 0.1 probability that the potential client will reject the offer.
(i) Determine the price that the contractor should quote in order to maximise
the expected payment that they receive from the client. (7 marks)

(ii)Suppose that after questioning the company is able to make the following three
statements:

“I am indifferent between receiving £120k for certain; or entering a lottery that will give me
a 0.9 probability of winning £150k and a 0.1 probability of winning £0.”
“I am indifferent between receiving £80k for certain; or entering a lottery that will give me
a 0.75 probability of winning £150k and a 0.25 probability of winning £0.”
“I am indifferent between receiving £100k for certain; or entering a lottery that will give me
a 0.85 probability of winning £150k and a 0.15 probability of winning £0.”
Given the above information: determine the price that the contractor should
quote to the client – and – give reasons for your answer. (12 marks)
[You may assume that U (£150k) = 1 and that U (£0) = 0]
Total [25] marks
5
Question 4
Major Ventures Ltd is considering the production of a new consumer item with a five year
product lifetime. In order to manufacture this item it would be necessary to build a new
manufacturing facility. You have been appointed as a consultant to advise the senior
management of the firm. After considering all possible alternatives, it becomes clear that
management only have the following three possible strategies. (Please note that all costs are in
present value terms and should not be discounted)
Strategy A: Build a large facility (at an estimated cost of £6m).
This strategy faces two types of market conditions (a) high demand with a
probability of 0.7 or (b) low demand with a probability of 0.3. If the demand is
high, the company can expect to receive an annual cash flow of £2.5m for each
of the next five years. If the demand is low the cash flow would consist of a loss
of £0.5m each year. (This is because of large fixed costs and inefficiencies).
Strategy B; Build a small facility (at an estimated cost of £3.5m)
This strategy faces the same market conditions types as Strategy A (i.e. (a)
and (b)). The cash flow over the five year period for the small facility is £0.25m
if the demand is low; and £1.5m if the demand is high.
Strategy C: Delay building the manufacturing facility
This strategy consists of leaving the decision for 12 months (while more
information is collected). The resulting information can be positive or negative
(with estimated probabilities of 0.8 and 0.2 respectively). At the end of the 12
months, management may decide to build either a large facility or a small
facility at the same cost as at present providing the information is positive. If
the resulting information is negative management would decide not to build any
facility at all.
Given positive information the probabilities of high and low demand change to
0.9 and 0.1 respectively (regardless of which facility is built). The annual cash
flows for the remaining four-year period (for either facility type) are the same
as those given for strategies A and B.

(a)Draw a Decision Tree to represent the alternative courses of action open to
Major Ventures Ltd.(8 marks)

(b) Determine the expected return for each possible course of action; and hence
decide the best course of action for the management of Major Ventures Ltd.
(10 marks)

(c)A building firm offers a discount to Major Ventures Ltd if they agree to have a
large facility constructed immediately. Determine the percentage discount
necessary to change the best course of action.(7 marks)

Total [25] marks
6
Question 5
(a) Calculate the expected return on the five product portfolio investment of £150k (shown
in Table 4) (3 marks)

Risk-return
characteristics
Product
AlphaBetaGammaDeltaEpsilon
Expected return on
product
20%10%5%15%3%
Proportion of
investment
0.050.450.10.250.15

Table 4
(b) Sealed-bids are known to attract more bids than the English Auction approach. Why is
this? (3 marks)
(c) For each of these two currency risk management strategies (External hedging,
Leading & lagging) discuss how it can be used to manage transactions risks.
(6 marks)
(d) Inflation is 5% per annum (pa) in the UK and 2% pa in the USA and it is expected to
remain at these rates. Nominal interest rates are 15% pa in the UK and 5.06% pa in
the USA. The spot exchange rate is $1.50/£.

(i)Determine the real interest rate in the UK and USA. Explain whether
your answers are what you would expect according to the International
Fisher relation.(3 marks)

(ii) Determine the one year forward exchange rate. (3 marks)

(iii)Determine what the spot rate in one year’s time will be according to the
Purchasing Power Parity Theory(3 marks)
(ii)Determine what the spot rate is expected to be in one year’s time
according to the expectations hypothesis; giving reasons for your
answer.(4 marks)

Total [25] marks
7
Question 6
(a) Portfolio theory aims to assist investors in creating an efficient portfolio; and
diversification is a strategic device for dealing with risk. Sensible companies diversify
their investments, markets, products & services.
Given these statements, comment on how companies might spread the risk of declining trade
and declining profitability. In your answer make reference to three of these business types:
large construction company, property management firms, financial institutions, confectionary
manufacturer, automobile manufacturers. (12 marks)
(b) A company has five distribution centres (DC) and the predicted profit (£k) of each
versus the anticipated state of the economy is given in Table 5.

EconomyProbabilityDC[1]DC[2]DC[3]DC[4]DC[5]
Excellent0.24050451060
High0.12030401550
Moderate0.42025402040
Average0.11015352530
Poor0.11518403520
Recession0.11214405510

Table 5
Discuss the correlation of the DC[1] v DT[2] data, compared to the correlation of the DC[3] v
DT[4] data. (5 marks)
(c) Consider two financial investment packages (Double-C and Treble-B) which comprise a
small portfolio, which has following risk-return characteristics and a total investment of $1
million. (Table 6)

Risk-return characteristicsDouble-CTreble-B
Expected return on security20%15%
Amount Invested$600,000$400,000
Standard-deviation of security9%7%

Table 6
Assuming a correlation coefficient of -1.0, 0.0 and +1.0, calculate the Portfolio risk. (8 marks)
Total [25] mark
End of Paper. Total marks available = 150
8
9
Present Value Table
Present value of £1 in “n” years at discount rate, r.
Discount rate (r)
Years (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 1
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826 2
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751 3
4 0.961 0.924 0.888 0.855 0.823 0792 0.763 0.735 0.708 0.683 4
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621 5
6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564 6
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513 7
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467 8
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424 9
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386 10
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350 11
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319 12
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290 13
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263 14
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239 15
Years (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 1
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 2
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 3
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482 4
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402 5
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 6
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 7
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233 8
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194 9
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 10
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 11
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112 12
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093 13
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078 14
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065 15
Annuity Table
Present value of £1 receivable at the end of each year for “n” years at discount rate, r.
Discount rate (r)
Years (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 1
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736 2
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487 3
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170 4
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791 5
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355 6
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868 7
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335 8
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759 9
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145 10
11 10.37 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495 11
12 11.26 10.58 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814 12
13 12.13 11.35 10.63 9.986 9.394 8.853 8.358 7.904 7.487 7.103 13
14 13.00 12.11 11.30 10.56 9.899 9.295 8.745 8.244 7.786 7.367 14
15 13.87 12.85 11.94 11.12 10.38 9.712 9.108 8.559 8.061 7.606 15
Years (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 1
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528 2
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106 3
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589 4
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991 5
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326 6
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605 7
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837 8
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031 9
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192 10
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327 11
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439 12
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533 13
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611 14
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675 15

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