There is no quick or easy formula when it comes to determining the expected monetary value (EMV); it is all based on probability. The value of commodities we own is evaluated by how much money they are worth, hence creating monetary value. With monetary value comes the probability of risks in different events, in this article we get to learn that there are positive risks (opportunities) and negative risks(threats). The decisions to be made are discussed by analyzing the expected monetary value.
Some of the decisions you make determine how much money you can expect in the future. The possibility of an outcome by its likelihood of occurrence are the determinants in this topic. In this article, we explore expected monetary value including its meaning, the associated formula, and how to calculate EMV.
What is the Expected Monetary Value?
Expected monetary value is a statistical concept that calculates the normal consequence when the future contains scenarios that may or may not transpire. An EMV analysis is usually recorded using a decision tree to stand for making decisions when facing multiple risks in events and their possible consequences on scenarios. The expected monetary value is a significant concept in project risk management which is for all types of schemes to create a quantitative risk analysis. As a risk management tool, the Expected Monetary Value can be used in projects to quantify and compare risks.
EMV is an estimated figure that shows how much money a complainant can practically expect in arbitration. Let’s think of it as a typical basis of the best-case scenarios where the risk brings opportunities and in the worst-case scenarios the risk brings threats. It accounts not only for the money figure allocated to each outcome but also for the probability of the outcome happening. EMV does not require additional costs, it only needs an expert who in this case could be a project manager to make the risk calculations.
Expected Monetary Value in Project Management
When it comes to risk management, although project managers have to primarily depend on their knowledge from past projects, there exists a technique known as Expected Monetary Value analysis to help in projects. The project team is expected to use expected monetary value to help them steer their way down the challenging paths. Even though many of the project management plans aspirants find this concept difficult to understand. However, the expected monetary value involves simple mathematical calculations.
Project management plan team is responsible for quantifying the features of the risks, either positive or negative, based on the company’s procedure and knowledge database. Once the project is quantified, the project manager could use the workings to calculate the EMV for each risk and the possibility reserve for the entire project respectively. Even though we said EMV involves simple calculations, it demands experience for one to appropriately substitute the right figure for each variable and analyze the final project possibility reserve using this technique.
Expected Monetary Value Formula
EMV calculates the average outcome when the future includes uncertain scenarios, which may either be positive (opportunities) or negative (threats). Opportunities are expressed as positive values, while threats are expressed as negative values. The formula for EMV of risk is as follows:
- Allocate a probability of occurrence for the risk.
- Allocate the monetary value of the impact on the risk when it happens.
- Multiply the values produced by step 1 and step 2.
Expected Monetary Value (EMV) = Probability of the risk (P) x Impact of the risk (I)
EMV = P x I
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How to Calculate the Expected Monetary Value
The EMV for any project is calculated by multiplying the probability of each consequence taking place by the value of each possible consequence and its Impact. Probability in this case is the likelihood of the occurrence of any event. For example, a coin has a 50% head outcome and 50% tail outcome when tossed.
The total number of events is 2 and hence the probability for head or tail outcome is ½. On the other hand, the impact is the money that you require to deal with the identified risk if it happens. For example, during project implementation, you note that there may be a breakdown in the gear you are using and you need to trade it with a new one. The cost of a new one is $7000. This is the impact value.
You are a project manager in an IT firm managing a software project and you identify a risk linked to the market claim. The possibility of risk is 20% and if it occurs you will lose $8000. Now we will calculate the EMV of this risk.
Probability of event happening: 20%
Impact of risk: – $8000
EMV = P x I
EMV = 0.2 x -8000 = -$1600
Suppose you are managing a large-scale farming project and your project has some risks that may cause postponement and cost overflows. For example:
Project risk 1: There is a 30% possibility of heavy rains. This will cause a delay in the project for 5 weeks and cost $9000.
Project Risk 2: There is a 20% probability of the rental charges of the equipment to increase, which will cost $10,000.
Project Risk 3: There is a 40% possibility of the cost of labor increases, which will cost $6000
Project Risk 4: There is a 25% possibility of increasing productivity the productivity of tractors due to the ground conditions. This will enable you to complete the project 3 weeks before and save up $10,000. Below is the calculation for the EMV of the project:
EMV = P x I
Project 1= 0.3 x -9000 = -2700
Project 2= 0.2 x -10,000 = -2000
Project 3= 0.4 x -6000= -2400
Project 4= 0.25 x 10,000= 2500
EMV of the project= -$2700+ -$2000+ -$2400+ 2500
EMV = -$4600.
Even after getting the EMV, a decision needs to be made hence the use of decision trees. In a decision tree diagram, a rectangular node is known as the decision node. There are no likelihoods at a decision node but we gauge the expected monetary value of the choices. In a decision tree, the first node is constantly a decision node. If there are more decision nodes then we gauge choices there and choose the best one and the expected value of this choice develops the expected value of the outlet leading to the decision node.
Expected Monetary Value Calculator
The expected monetary value calculator computes the project management metric. The calculator returns the EMV in U.S dollars. However, it can be automatically changed to other currency units through the pull-down menu.
You just need to enter the impact and probability of occurrence in the EMV to compute the expected monetary value.
Advantages of Expected Money Value
There are many benefits that expected money value provides in risk management. Here are some key gains:
- provides you with an average outcome of all the uncertain events that have been identified. This helps to be proactive and make necessary plans regarding such events.
- EMV aids with the calculation of contingency reserve.
- It facilitates decision tree analysis. This means that EMV makes it easier to understand problems and solutions.
- does not need any costly resources. The opinions of experts are what mainly counts.
- When making procurement plans, EMV helps to decide on whether to make or buy project items. This decision is vital when it comes to cost cutting and operating within the set budget.
Disadvantages of Expected Money Value
Although EMV is beneficial, it has the following shortcomings:
- Usually, expected money value is not applied in either small or small-medium-sized projects.
- EMV requires expert opinions to make decisions regarding probability and effects of risk. This suggests that outcomes may be affected by personal bias.
- The EMV technique functions well in situations where there are large number of risks. This is because EMV helps to spread the impact of risks.
- The final outcome of expected monetary value analysis is affected if positive risks are not included in analysis.
When performing EMV analysis, risk attitude should be kept at a neutral level. Otherwise, it can affect the calculation. Moreover, the reliability of the analysis is dependent on all the data provided, which acts as the input to the EMV technique. Overall, the analysis of expected monetary value makes it easier to enumerate risks, compute the contingency reserve and help you select the finest choice in a decision tree analysis. In addition, the dependability of this analysis depends on the input data; therefore, the data quality valuation should be thoroughly attained. You must have an unbiased attitude towards the risk, this is to avoid wrong calculations. This technique increases the assurance level in achieving the project objectives. Expected monetary value and decision tree analysis are both modules of project management and its body of facts. Therefore, either or both of these topics could be on your PMP examination