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Alexis, J. (2022, October 23). Expected monetary value (EMV) explained [Video]. https://youtu.be/jGagFcTmfWM.
In this short video, I explain the concept of expected monetary value (EMV) and its relation to the concept of utility in economics. Utility is a measure of the total value or relative preference of a particular outcome (Anderson et al., 2015). When making decisions, you are selecting among alternative choices. EMV will lead to the selection of the decision alternative with the best expected monetary value. Using EMV assumes that the decision maker is risk neutral, meaning they are neither risk adverse nor risk seeking. Instead, decisions are made based on the value of the average outcomes.
EMV is essentially a weighted average, where the weights correspond to the probabilities of different outcomes.
There are three key assumptions that validate the application of EMV:
1. There is a large number of possible outcomes (law of large numbers). It does not to be infinite. For example, a large number of risks that may impact the objectives of your project.
2. You are able to assign a value (e.g., economic impact) to each possible outcome.
3. You are able to associate a probability with each possible outcome.
If these assumptions are not met, EMV should not be used.

EMV is calculated by multiplying the possible economic impact (x) of a risk by its probability (p) AND SUMMING the products (Anderson et al., 2015; PMI, 2017). Therefore, you must have identified many potential risks and their associated probabilities. The formula for EMV is shown below.

EMV = ∑ (pi × xi) = Sum (Probability x Impact).
Where:
EMV is the expected monetary value.
pi is the probability of a risk event i occurring.
xi is the monetary value associated with the event i.

The product (xi * pi) is a probabilistic estimate called an individual risk exposure, but you cannot, by definition, call it expected value.

The expected monetary value decision-making model has received criticism for its perceived oversimplification (Anderson et al., 2015), as well as for its failure to account for the decision maker’s risk preferences (Kahneman & Tversky, 1979; Simon, 1979). While the expected value model is a useful tool for evaluating the potential outcomes of a decision based on their probabilities, it may not accurately reflect the complexities of real-world decision making. Additionally, the model assumes that decision makers are risk-neutral, when in fact individuals may have varying levels of risk tolerance that can influence their choices. As such, the expected value model should be used in conjunction with other decision-making models and techniques to arrive at the best possible outcome.
The key takeaway from this short video is that the expected value of a decision is calculated by multiplying the payoff of each outcome by its probability AND summing the products (Anderson et al., 2015; PMI, 2017). To find EMV, you must take the sum of the products.

References

Anderson, R. D., Sweeney, J. D., Camm, D. J., & Cochran, J. J. (2015). Quantitative methods for business (13th ed.). Cengage Learning.
Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263-291. doi:10.2307/1914185
Project Management Institute. (2017). A guide to the project management body of knowledge (6th ed.).
Simon, H. A. (1979). Rational decision making in business organization. American Economic Review, 69(4), 493-513.

Below are a few examples of my videos. If you’re interested in watching more videos like these, please visit Management’s YouTube channel at https://studio.youtube.com/channel/UCGo0QLVbu4AGuZ6GBmZ5O5w.

Alexis, J. (2022, May 13). Uncertainty modelling in Primavera Risk Analysis [Video]. https://youtu.be/-w8Kobn-G_g.

Alexis, J. (2022, August 24). The application of probability distributions to project cost and schedule management [Video]. https://youtu.be/2gvwLZQ1vNU

Alexis, J. (2022, September 29). The basics of APA writing style (7th ed.) [Video]. https://youtu.be/Lown9oKaGVk.

Alexis, J. (2023, January 15). The basics of sustainability [Video]. https://youtu.be/yOjMv5Ewb4k.