Question

How do you calculate risk and cost in capital projects?

Answer 1

To calculate risk in capital projects the first step is to identify the risk. A capital project faces three main types of risks – external, project and internal. External risks are beyond the control of the capital project management team. Project risks consists of time risk, costs risk, technological risk etc. Internal risks arises due to intrinsic conditions and consists of resource risk, project member risk etc.

Once the risk factors are determined then the quantum of risk is computed using different techniques like sensitivity analysis, scenario analysis, simulations etc. Risk can be determined using either statistical techniques or using conventional techniques. Statistical techniques of computing risks are techniques of probability, standard deviation and coefficient of variation. Conventional techniques of computing risks are techniques of payback, risk-adjusted discount rate and certainty equivalent.

To compute costs associated with a capital project we generally use a period by period dimension and a project by project dimension. A project is analyzed over its entire life span and all costs associated with the project are determined. To do this there is a comprehensive identification stage in which the types of investments necessary for the project is calculated. Then the next step is to determine the recurring costs like annual operating and maintenance costs etc.