Expected Monetary Value

Posted on September 29, 2009 by

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When dealing with risk, probabilities of different scenarios and the associated financial loss or gain can be calculated mathematically. An example of analyzing Expected Monetary Values is the decision tree, which is part of the PMBOK®’s Perform Quantitative Risk Analysis process.

This can be applied to wide variety of project situations. For example, Carl is trying to decide whether or not to take a former client to court. Percy, his lawyer, tells him that if he takes the client to court, there is about a 25% chance that the jury will side with him and award him what will amount to $50,000 after paying legal fees. However, there is a 75% chance that the jury will not side with him, and he’ll have to pay $10,000 for legal fees. If he takes the $5000 settlement that the former client is offering, it’s certain that he won’t lose any money. Carl calculates the EMV for going to court by taking the probability multiplied by the amount of money for both the winning outcome and the losing outcome and then combining them together. So, for winning in court,  .25 * $50,000 = $12,500. For losing in court,  .75 * $10,000 = -$7,500. Combining the two outcomes for going to court is $12,500 – $7,500 = $5,000. This just happens to be the same amount that is guaranteed if he takes the $5,000 settlement. So in this case, the EMV is the same for the two choices, so the decision must be made on other criteria, such as risk tolerance,  for which EVM does not take into consideration, or the time involved and effects of negative publicity.
EMV Lawsuit Decision Tree