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Saturday, February 16, 2013

Expected Monetary Value Analysis (EMV)

Expected Monetary Value Analysis or EMV Analysis in short is the 2nd tool and technique in the Quantitative Risk Analysis and Modeling Techniques sub-group. As you might remember, the 1st tool was Sensitivity Analysis that resulted in a Tornado Diagram, which was covered in the previous chapter. 

Expected Monetary Value Analysis calculates the average outcome of future scenarios that may or may not occur. The may or may not occur indicates the fact that, the future scenario is a risk and hence has a probability % based on which it occurs. Isn’t it? 

EMV Analysis calculates the Monetary Value of the Impact of this scenario if it occurs in future – Today. 

If you cannot understand the concept of EMV Analysis clearly yet, don’t worry. We will take a look at a few examples next that should help you understand clearly what EMV Analysis is. 

Some Points to Remember: 

• EMV Analysis is used to make decisions (Ex: Decision Tree Analysis). Don’t worry about Decision Tree Analysis just yet. That is going to be the next chapter
• EMV Analysis looks at both probability and impact together 
• When using EMV we must be in a “Risk Neutral” mind-set and not Risk Averse or Risk Seeking. Remember the chapter titled Factors that Influence Risk Communication where we took a look at people and their Risk Attitudes
• When you have multiple scenarios, you add the EMV of all the possible outcomes together before taking the decision. 

Formula for Expected Monetary Value: 

EMV = Probability * Impact 

Some Examples: 

Example 1: 

Impact of a Risk = $ 10,000 
Probability of Risk Occurring = 15% 

EMV = ??? 

EMV = Impact * Probability = 10,000 * 15% = $ 1500/-

$1500 is the Expected Monetary Value of this scenario. i.e., if this risk were to materialize, the monetary value of the occurrence will be $1500. 

In the exam, it is easily possible that the same question as Example 1 could be worded into a long paragraph to check if you understand the concept. The following example does just that. 

Example 2: 

Rajesh is the Project Manager for Project A and is doing EMV Analysis. For one of the top-priority risks he can see that the impact will be $10,000 if it occurs. The Risk Register also states that, as per the initial analysis, the probability of this risk materializing is 15%. What would be the Expected Monetary Value of this Risk, if Rajesh decides to perform EMV Analysis? 

Can you guess what the Answer will be? 

The same $1500. All this question does is, put the camouflage the important details like impact and probability that are required to calculate the final answer along with loads of irrelevant information which can easily confuse a novice Risk Manager. 

In most cases, we will be working with multiple risk related scenarios and hence, the eventual or total EMV is the sum of all the individual EMV’s. The following example does just that. 

Example 3: 

Project X has a 60% Probability of success with an impact of $50,000 and has a 40% chance of failure with an impact of $-20,000. What is the Expected Monetary Value of this Project? 

EMV of success = 50000 * 60% = $ 30,000

EMV of failure = -20000 * 40% = $ -8,000 

Total EMV = $ 22,000/-


In all cases, a positive EMV indicates that it is an opportunity while a negative EMV indicates a Risk/Threat. 

Now that we know about EMV Analysis, we are well equipped to learn about Decision Tree Analysis which will be the topic of discussion in the next chapter. 

Prev: Sensitivity Analysis

Next: Decision Tree Analysis

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