---
title: "Short note: sources of uncertainty"
subject: "Engineering Economics"
chapter: 6
key: "semester_6/engineering_economics:short-note-sources-uncertainty"
source: https://www.bctengineer.com/q/semester_6/engineering_economics/short-note-sources-uncertainty
site: BCT Engineering
---

# Short note: sources of uncertainty

Engineering Economics · Chapter 6: Risk Analysis

- Asked in: 2068 Jestha, 4 marks; 2065 Kartik, 4 marks (asked 2 times)
- Answer checked by Claude Opus 5.5 (high effort) on 2026-10-14
- Page: https://www.bctengineer.com/q/semester_6/engineering_economics/short-note-sources-uncertainty
- Whole chapter: https://www.bctengineer.com/md/semester_6/engineering_economics/chapter-6

## Question

Explain the uncertainty and its sources.

## Short answer

Uncertainty exists when future outcomes cannot be predicted confidently and no reliable probabilities are known. Main sources: estimate inaccuracy, business environment, equipment type, study period length, economic conditions, political/legal factors, natural factors, and MARR selection. Handled via break-even, sensitivity, scenario analysis, expected value, decision trees, and simulation.

## Answer

**Uncertainty** exists when the outcome of a future event, or the values to be used in an economic analysis, cannot be predicted with confidence and no reliable probabilities are known. Engineering economy decisions rest on estimates of cash flows, lives and interest rates that will happen in the future, so some uncertainty is always present.

#### Main sources of uncertainty
1. **Inaccuracy of estimates:** first cost, revenues, operating and maintenance costs and salvage value are forecasts, and errors in them change the result. Estimates of new technology are especially weak.
2. **Type of business and its environment:** competition, changes in demand, market prices and customer taste change revenues.
3. **Type of physical plant and equipment:** the life, breakdown rate and output of equipment may differ from the estimate. New technology can make it obsolete early.
4. **Length of the study period:** the longer the horizon, the larger the uncertainty; long-lived projects such as hydropower depend on conditions many years ahead.
5. **Economic conditions:** inflation, exchange rate, interest rate and taxes (changes in government policy).
6. **Political and legal factors:** policy change, delays in approvals, strikes, and in Nepal, bandhs and changes in regulations.
7. **Natural factors:** hydrology, earthquakes, floods and weather affecting construction and operation.
8. **Selection of the MARR:** the discount rate used is itself a judgement.

#### How it is handled
Break-even analysis, sensitivity analysis, scenario analysis, expected value with probabilities, decision trees and simulation are used to examine the effect of uncertain estimates on the decision.

## Check yourself

The answer's key points as multiple-choice questions, with the correct option and why.

1. Uncertainty in engineering economy means that:
   A. Future outcomes or values cannot be predicted with confidence and no reliable probabilities are known
   B. All outcomes have known probabilities
   C. Cash flows are exactly known
   D. The interest rate is zero
   Answer: A. Uncertainty arises because estimates relate to the future and reliable probabilities are not available. (Key point: Meaning of uncertainty)

2. How does the length of the study period affect uncertainty?
   A. Longer study periods reduce uncertainty
   B. It has no effect
   C. The longer the horizon, the larger the uncertainty
   D. Only short periods are uncertain
   Answer: C. Long-lived projects like hydropower depend on conditions many years ahead, so uncertainty is greater. (Key point: Source: length of study period)

3. Which of these is NOT given as a source of uncertainty?
   A. Inaccuracy of estimates
   B. Economic conditions such as inflation and exchange rate
   C. Natural factors such as floods
   D. Certainty of the MARR being fixed by law
   Answer: D. The selection of MARR is itself a judgement and therefore a source of uncertainty, not a certainty. (Key point: Sources of uncertainty)

4. Which technique is used to examine how uncertain estimates affect a decision?
   A. Straight-line depreciation
   B. Sensitivity analysis, break-even analysis or simulation
   C. Bank reconciliation
   D. Cash flow rounding
   Answer: B. Break-even, sensitivity, scenario, expected value, decision tree and simulation methods are used. (Key point: Handling uncertainty)