P2: Risk and control

Answer: D. Expected value of Strategy A = (0.70 × £80,000) + (0.30 × £20,000) = £56,000 + £6,000 = £62,000. Since £62,000 > £55,000, The first strategy has the higher EV and should be chosen based on EMV alone. A common error is to weight the probabilities incorrectly — for example, 0.60 × £80,000 + 0.40 × £20,000 = £48,000 + £8,000 = £56,000, which would invert the comparison. EMV analysis does not incorporate risk preference; a risk-averse manager might still prefer the certain £55,000, but the pure EMV criterion points to the first strategy. The certain £55,000 is lower than £62,000, so it is not chosen on EMV alone, and the two values are not equal.

Answer: A. The rollback method works from right to left — starting with the known outcomes at the ends of the branches, then working backwards through the tree. At chance nodes (circles), the expected value is calculated by probability-weighting the outcomes. At decision nodes (squares), the best option is selected (the highest EV branch), and other options are pruned. Working forwards from the initial decision would not be the rollback method; that is a forward pass used in different contexts. Selecting purely on highest single outcome ignores probability, and minimising the worst outcome is a maximin strategy, not the expected value rollback method.

Answer: B. The TARA framework identifies four possible risk responses: Transfer (pass the risk to a third party, e.g. through insurance), Avoid (eliminate the risk-creating activity), Reduce (take actions to lower the probability or impact of the risk), and Accept (consciously decide to live with the risk, often because the cost of other responses exceeds the benefit). The other options include plausible-sounding words but do not correctly name all four TARA responses — Analyse, Assess, Retain and Tolerate are not the correct TARA labels.

Answer: C. Taking out insurance passes the financial consequences of the risk to a third party (the insurer) in exchange for a premium — this is the defining feature of the Transfer response in TARA. Avoidance would require ceasing the storage activity altogether to eliminate the risk. Reduction would involve taking preventive measures to lower the probability or potential impact of flooding, such as building flood defences. Acceptance would mean consciously choosing to do nothing and bearing the cost of any flood loss directly, which is the opposite of paying for insurance.

Answer: D. Upside risk refers to the possibility that outcomes could be better than expected — in other words, positive uncertainty or opportunity. Just as downside risk can be managed to limit harm, upside risk can be actively managed to maximise the chance of favourable outcomes. Risk management therefore encompasses both threat avoidance and opportunity pursuit, not just harm reduction. Upside risk is not inherently harmful (that is downside risk), and it is absolutely a recognised concept in formal risk management frameworks, including those used by professional accountants.

Answer: A. Professional accountants produce or assure financial information that market participants, investors, lenders and governments rely on to make decisions. If accountants were to act solely in client interests at the expense of accuracy, completeness or integrity, public trust in financial information would erode, undermining the functioning of capital markets and the broader economy. This is why the CIMA Code of Ethics requires accountants to act in the public interest as a fundamental principle. Acting ethically does not always maximise short-term employer profit, the public interest obligation extends beyond audit engagements, and it has very practical consequences — including professional sanctions — for real decisions.

Answer: B. Sensitivity analysis examines how much a single key variable (such as sales volume, selling price or operating cost) can change before the NPV falls to zero, without assigning probabilities to different scenarios — it highlights which variables the decision is most sensitive to. Expected value analysis instead assigns probabilities to possible outcomes and calculates the probability-weighted average, giving a single expected outcome. The two techniques approach uncertainty differently and are not equivalent. The descriptions of which technique uses probability estimates are correctly stated here, and sensitivity analysis does not eliminate uncertainty — it maps its consequences.

Answer: A. EV of Strategy A = (0.40 × £150,000) + (0.60 × £20,000) = £60,000 + £12,000 = £72,000. EV of Strategy B = (0.40 × £80,000) + (0.60 × £60,000) = £32,000 + £36,000 = £68,000. Strategy A has the higher EV (£72,000 > £68,000) and would be selected under the pure EMV criterion. A risk-averse manager might still prefer Strategy B's lower variance. The £85,000 figure is a simple average of Strategy A's outcomes (£150,000 + £20,000) ÷ 2, ignoring the unequal probabilities.

Answer: B. The fundamental limitation of EMV is that it averages outcomes weighted by probability but ignores the spread of those outcomes — a project with the same EMV as another but with a range of outcomes including catastrophic losses would be treated identically, even though a risk-averse manager would rationally prefer the less variable option. Risk attitude, scenario analysis and utility theory are used alongside EMV to address this limitation. EMV calculations are straightforward, not inherently complicated. The probability inputs do affect the result significantly, and EMV can handle any number of outcomes, not just two.

Answer: C. Good market outcome: revenue £120,000 − further investment £20,000 = net £100,000 from that branch. Poor market outcome: revenue £15,000, no further investment. Expected value of outcomes = (0.55 × £100,000) + (0.45 × £15,000) = £55,000 + £6,750 = £61,750. Less initial investment £30,000 = expected net value £31,750. The £61,750 figure is the EV before deducting the initial investment. The £13,250 figure might arise from netting incorrectly. The £52,500 figure could come from applying 55% to £120,000 with no deduction for the further investment.

Answer: D. Insurance transfers the financial consequences of a risk to a third party (the insurer) in exchange for a premium payment — this is the defining feature of the Transfer risk response in TARA. Avoidance would require the company to stop giving advice altogether. Reduction would involve actions such as improved training or quality control to lower the probability of negligent advice occurring. Acceptance means consciously deciding to retain the risk and bear any resulting loss internally, which is the opposite of paying a premium to transfer it.

Answer: A. When the cost of mitigation substantially exceeds the expected impact of a low-probability, low-impact risk, acceptance is the rational TARA response — the organisation consciously decides to absorb the risk rather than spend more than it is worth to mitigate it. Avoidance would be entirely disproportionate for a minor IT outage. Reduce does not mean all risks must be reduced regardless of cost — cost-benefit analysis is central to choosing between risk responses. Taking out insurance for every minor, low-cost risk would create unnecessary expense and is not a principle of good risk management.

Answer: B. Big data and analytics can enhance risk identification by revealing patterns, correlations and emerging signals in large datasets that traditional analytical methods might miss, enabling earlier and better-informed risk responses. They do not eliminate uncertainty — risk management remains necessary precisely because uncertainty persists. Analytics supports human judgement rather than replacing it entirely; interpreting risk patterns and deciding on appropriate responses still requires managerial judgement, context and accountability. Big data has substantial and growing application in risk management across many industries.

Answer: C. The CIMA Code of Ethics requires professional accountants to maintain integrity and refuse to be party to the preparation of misleading information. The appropriate first response is to decline the request and escalate through appropriate internal channels — such as a more senior manager, internal audit or the audit committee — before considering more drastic action. Complying would be a clear breach of the fundamental principle of integrity. Adding an undisclosed footnote would not make the misleading presentation acceptable. Resigning immediately, before attempting internal resolution, would typically be an extreme last resort rather than the appropriate first step.

Answer: B. Expected cash returns = (0.65 × £100,000) + (0.35 × £5,000) = £65,000 + £1,750 = £66,750. Less initial investment £40,000 = expected net value £26,750. The £66,750 figure is the expected return before deducting the investment. The £52,500 might arise from averaging outcomes without using probabilities correctly. The £61,750 misapplies probabilities to the wrong figures.

Answer: C. Sensitivity = NPV ÷ PV of the variable = £8,000 ÷ £64,000 = 0.125 = 12.5%. This means contribution can fall by 12.5% before the NPV reaches zero — identifying how exposed the project is to a reduction in margin. A common error is to divide £8,000 by £100,000 (8%) if a different base is used, or to confuse the ratio (£64,000 ÷ £8,000 = 8) with the sensitivity percentage. 64.0% reads the £64,000 as a percentage, and 6.25% does not follow from the figures.

Answer: A. A management information system genuinely provides faster, more accurate data to support decision-making — that is its primary benefit. Its costs include implementation, data migration, training, and ongoing licence or maintenance fees. Information systems do not eliminate business risk, replace all employees, remove the need for budgeting, guarantee perfect forecasts, or make financial statements unnecessary — these reflect a fundamental misunderstanding of what an information system does.

Answer: B. An organisation with a low risk appetite will generally not tolerate high-impact risks even at medium probability — the potential loss is simply too large relative to its risk tolerance. Transfer (e.g. insurance) or Avoidance (eliminating the activity) are therefore the most consistent responses. Acceptance would be more appropriate for a risk-tolerant organisation or a genuinely low-impact risk. Minimal reduction that leaves substantial residual risk is also unlikely to satisfy a risk-averse organisation. TARA applies across the full range of risk probabilities and impacts.

Answer: C. 75% learning curve: cumulative average time doubles at 75% of previous. First unit: 80 hours. After 2 units: cumulative average = 80 × 0.75 = 60 hours; total = 2 × 60 = 120 hours. After 4 units: cumulative average = 60 × 0.75 = 45 hours; total = 4 × 45 = 180 hours. Total labour cost for 4 units = 180 × £25 = £4,500. A common error applies no learning: 4 × 80 × £25 = £8,000. Another applies 75% once to total hours: 4 × 80 × 0.75 × £25 = £6,000, incorrectly treating it as a flat reduction. £3,000 is the cost of the first two units only (120 hours × £25).

Answer: A. Maximin selects the option whose worst-case outcome is the least damaging — it is a conservative, risk-averse criterion. Maximax is the opposite: it selects the option with the highest possible upside, reflecting a risk-seeking attitude. Expected monetary value uses probability-weighted averages, not worst-case thinking. Minimax regret minimises the maximum difference between the actual outcome and the best outcome that could have been achieved under each scenario — a different concept again.

Answer: B. Proactively increasing capacity to benefit from an anticipated demand surge is an example of managing upside risk — recognising positive uncertainty and taking deliberate action to capture the opportunity before it fully materialises. This is the proactive, value-creating side of risk management. It is not downside risk management (there is no adverse consequence being mitigated here), not acceptance (which is passive), and not transfer (which passes consequences to third parties).

Answer: C. While big data can provide richer analytical insight, it also creates real challenges: managing large, diverse, fast-moving datasets requires substantial investment in technology, skills and data governance, and data quality problems can undermine analytical outputs ("garbage in, garbage out"). Big data does not eliminate uncertainty — it can reduce it in some areas while creating new uncertainties in others. The quality of underlying data fundamentally affects decision quality, and human interpretation remains essential for contextualising and acting on algorithmic outputs responsibly.

Answer: A. EMV is most meaningful when a decision is repeated many times, since the average then approximates the expected value. For a one-off decision, the actual outcome is either good or bad — there is no averaging across repetitions. A team that cannot absorb an £800,000 loss may rationally decline to launch even with a positive EMV, since the expected value does not protect them from the possibility of the worst case actually occurring. Risk aversion in one-off, high-stakes decisions is not irrational — it reflects genuine concern about downside exposure that EMV alone does not capture.