A value at risk (VaR) measure/ method that connects the risks associated with two essential aspects in project management: time and cost of completion of a project.Simply put, it is the loss that may occur at a specific level of probability over the life of a project. In calculation, a project’s value at risk for a specific confidence level (e.g., 95%) is the difference between the mean value of the project’s net present value (NPV) and the value that may only be attained at a 5% likelihood of occurrence.
For example, a 10-year project is expected expected to generate annual cash flows that are normally distributed with a mean of $100,000 and standard deviation of $20,000. Its project value at risk (project VaR) at a probability of 5%, can be calculated as follows:
Project VaR (PVaR) for a year is:
PVaR = 1.645 × $20,000 = $32,900
Where 1.645 is the confidence level corresponding to a 5% probability of loss occurrence.
The PVaR for the entire project life is:
PVaR = 1.645 × $20,000 × 10 = $329,000
This represents the maximum amount of loss (i.e., the maximum amount of decrease in the value of the project) at a confidence level of 95%.
