Optimum budget allocation method for projects with critical risks

In this paper, the authors analyze the trade-off problem between project budgets and critical risks. Project managers face the problem to balance cash flows and risks when preventive risk response plans require additional costs. Mathematical modeling approach is used with a metric called risk-based project value (RPV). RPV is an evaluation of projects calculated with cash flows and risk probabilities of activities that constitute the project network diagram. There exists an optimal solution for the budget allocation problem that maximizes the expected project value. There is a condition where additional budgets can improve the project value. The study result suggests that there should be an integrated process to optimize the budget plan with the risk management plan. Methods are developed to obtain optimum budget allocations for projects with various types of activity networks. Evaluation of the marginal cost sensitivity on the RPV supports project manager's decisions on reallocation of budgets.

► We analyzed the trade-off problem between project budgets and critical risks.
► Theoretical framework of risk-based project value (RPV) was applied.
► There exists an optimal budget allocation that maximizes the expected project value.
► There is a condition where additional budgets can improve the project value.
► Marginal cost sensitivity on the RPV will support manager's decisions.