Treating, quantifying and timing risk

Accounting Ahead | Original study resource | accountingahead.com.au

Treating, quantifying and timing risk

MODULE 5 | 5.4.2 | STUDENT COMPANION

After the five-step assessment, managers understand each option's risks and how they could affect its

goals and the organisation as a whole. The next task is to choose a cost-effective treatment for each risk.

Four ways to treat a risk

Eliminate

Remove the source, or drop the option or its risky part. Peak:

never store card details; drop the outdoor trips

Accept

Take the chance knowingly, because the rewards justify it. Peak:

some older members won't use the app

Reduce

Make it less likely or less severe, even by redesigning the option.

Peak: strong passwords, two-step logins, test the provider's

security

Share or transfer

Pass some or all of it to another party. Peak: compensation for

outages in the contract; cyber insurance; a landlord who funds

part of the fit-out

Every control lowers the likelihood or the impact, and must be monitored as conditions change

Every control either lowers the likelihood of a risk or softens its impact, but controls weaken as conditions

change. Risk management never stops: monitor, test and replace controls when they no longer work.

Business analytics in risk assessment

Quantitative assessments estimate how likely a risk event is, how severe it would be, and what a treatment

would probably achieve. One of the biggest external risks is simply whether the market is big enough to sustain

the new strategy.

Technique What it does Peak (imagined)

Probability analysis Estimates the chance of each outcome,

for example by running thousands of

simulations

Vary membership, prices and costs; count how

often the fourth gym loses money

Stress testing Asks whether the organisation survives if

things go badly wrong

Memberships a third below forecast for two

years, and higher interest rates: can Peak still

repay its loan?

Comparing

treatments

Ranks treatment plans against set criteria Profitability, market share, potential for

disruption

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Accounting Ahead | Original study resource | accountingahead.com.au

A what-if analysis for two of Peak's options

Peak's annual revenue $6,000,000

Fourth gym: value = $6.0m x 25% of revenue $1,500,000

Impact of the rival's expansion: $1.5m x 40% -$600,000

Fourth gym: expected value $900,000

School programs: value = $6.0m x 6% of revenue $360,000

Impact of school budget cuts: $360,000 x 10% -$36,000

School programs: expected value $324,000

Value = annual revenue x expected share; impact of risk = value x expected % reduction

The method is deliberately simple. Applying it to every option allows a fair comparison; the most promising

options are then modelled in more detail.

Cost-benefit analysis: Peak's booking app

Cost $80,000 up front. Each year: extra bookings, plus $25,000 of staff time saved, less $20,000 of fees.

Benefits last four years and are discounted at 10% (annuity factor 3.170).

Scenario Extra bookings a

year

Net benefit a year Present value (x 3.170) NPV

Worst $20,000 $25,000 $79,247 -$753

Expected $60,000 $65,000 $206,041 $126,041

Best $100,000 $105,000 $332,836 $252,836

Discounting to net present value puts costs and benefits that arrive at different times into today's dollars, and

lets options of different lengths be compared. Costs are usually easier to pin down than benefits, so model a

range: here the worst case roughly breaks even and the best case is large, an attractive shape.

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Accounting Ahead | Original study resource | accountingahead.com.au

Timing risk: go early or wait?

Go early

Profits before competitors arrive

Risk: failures, returns and refunds

Risk: damage to reputation from unhappy customers

Needs service, systems and processes that fix

problems fast

Wait

A product that works properly

Risk: rivals claim the market first

Risk: the window of opportunity closes

Needs confidence that demand will still be there

or

The best window: enough demand exists, but competition is not yet intense

Peak's window (imagined): open the fourth gym before the suburb's population grows and it could lose money

for years; wait too long and the rival may claim the suburb first.

Case note: Cyberpunk 2077

CD Projekt's Cyberpunk 2077, first due in April 2020, was delayed three times and launched on 10 December

2020. It was well reviewed on PC but badly bugged on the older PlayStation 4 and Xbox One, and the studio

admitted it had not shown those versions before launch. It offered refunds, and on 17 December (US time) Sony

removed the game from the PlayStation Store until 21 June 2021. The shares, at a record PLN 464 days before

launch, fell to PLN 296 within five days, and a shareholders' class action was later settled for US$1.85 million.

After major patches and the 2023 Phantom Liberty expansion, sales passed 40 million copies by July 2026.

Sources: Reuters factbox, 25 September 2023; VGC, 18 December 2020 and 3 July 2026; Game World Observer, 16 December 2021.

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Accounting Ahead | Original study resource | accountingahead.com.au

Practice questions

MODULE 5 | 5.4.2 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - Choose a treatment

Risk for Bassline Festival (an imagined three-day outdoor

festival)

Treatment and why

(a) A storm forces one day to be cancelled

(b) A crowd crush at the main stage

(c) The headline act cancels

(d) Minor noise complaints from neighbours

(e) Fake tickets sold on unofficial resale sites

(f) A food vendor causes food poisoning

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Question 2 - What-if and cost-benefit

(a) Calculate the value, the impact of the risk and the expected value. (b) Calculate the NPV in each case. (c)

Comment.

Item Tallowwood Furniture (imagined)

Annual revenue $8 million

Online store's expected share of revenue 10%

Risk: price competition from large online retailers Could cut that return by 30%

Upfront cost of the online store $300,000

Net benefit a year, for four years Expected $120,000; worst $70,000; best $170,000

Annuity factor (8%, four years) 3.312

Question 3 - Launch for Christmas, or wait?

Whizbot Toys (imagined) plans a talking robot for Christmas. Testing shows the voice software crashes about

once in every 20 hours of play; a fix needs eight more weeks, meaning a February launch. Rivals are expected

to launch similar toys next year. Advise the board.

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Accounting Ahead | Original study resource | accountingahead.com.au

Worked answers

MODULE 5 | 5.4.2 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Bassline Festival

Risk Treatment (sample answers)

(a) Storm Share: weather and cancellation insurance; reduce with a wet-weather plan

(b) Crowd crush Reduce: site design, barriers, capacity limits, trained crowd staff. Never simply accept a risk

to life

(c) Headline act

cancels

Share: contract clauses and insurance; reduce: a standby act

(d) Noise complaints Accept, while keeping within sound limits and talking with neighbours

(e) Fake tickets Reduce: an official resale platform and named tickets

(f) Food poisoning Share and reduce: require vendor licences and insurance; inspect stalls; eliminate high-risk

vendors

Question 2 - Tallowwood Furniture

(a) Value: $8m x 10% $800,000

Impact of risk: $800,000 x 30% -$240,000

Expected value $560,000

(b) Expected NPV: $120,000 x 3.312 - $300,000 $97,440

Worst-case NPV: $70,000 x 3.312 - $300,000 -$68,160

Best-case NPV: $170,000 x 3.312 - $300,000 $263,040

(c) Positive on average, but the worst case loses money: consider a staged start, such as selling through a marketplace first

Question 3 - Whizbot Toys

Going early captures Christmas sales before rivals arrive, but crashes will bring returns, poor reviews and

lasting damage to the brand.

Waiting protects the product's reputation, but misses the biggest selling season.

Possible middle path: launch only if a free update can fix the fault before Christmas Day, with easy returns

and honest communication; otherwise launch in February with a strong campaign, since rivals aren't due until

next year.

GLOBAL STRATEGY AND LEADERSHIP | M5 | 5.4.2 | WORKED ANSWERS

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