Measurement of benefits and costs: uncertainty and risk
Since the future can never be known with certainty, measurement of benefits and costs raises the issue of uncertainty and risk, especially when benefits and costs have to be estimated over extended periods of time. There are three simple and commonly used procedures for taking account of uncertainty or risk. The first method involves adding an uncertainty or risk premium to the minimum return required of projects. A second method for dealing with uncertainty or risk is closely allied to the first and involves truncating the time horizon of the analysis. The third of the simple approaches to the incorporation of uncertainty or risk into analyses is to estimate benefits and costs on a conservative basis. As an alternative approach for dealing with risk and uncertainty, sensitivity analysis is always available. At the same time, the approach may also be used in conjunction with probability adjustments to show expected values on the basis of different probability adjustments.