Part 2. MM4XL Tools > 1. Strategic Tools > Risk Analyst > 2. Simulation Never heard of it > Chance of failure

Risk Analyst

Chance of failure

The chance of failure (CoF) is the probabilty that the object of the risk assessment will fail, which is a similar concept to that of Break Even Point (BEP). The BEP is that point where all costs of a venture are covered by the revenues and no profit has yet been made. The CoF is that value in the distribution before which there are unsustainable values for the venture and above it there are acceptable values. For example, a new product launch is acceptable to top management only if it generates over 6 millions in sales. The chart below shows a 9% CoF as the result of a simulation session for the variable Sales.

 Monte Carlo Simulation Software: Management Process Risk Analysis

CoF refers only to the probability that the whole project (the object of the risk assessment) fails. If any variable without the power of causing the whole system to fail shows values in the unfavourable region of that distribution this is not CoF. A car provides a good example: virtually any part of a car can fail, however only some parts have the power to stop the car from running. Opposed to the CoF there is the Total Cost of Success (TCoS), calculated with.

 Monte Carlo Simulation Software: Management Process Risk Analysis

A typical pitfall is that of replacing undesired simulation values with zeros, to avoid falling in the failure region of the distribution. This is not a good idea for a number of reasons, one of which is that the system may generate incomparable arrays of simulated values due to their varying length. Refer to Koller (1999) for more detail.

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