Expected Monetary Value
An accountant may give a slightly different answer to the previous question by looking at the 'Actuarial' cost of the project using the Expected Monetary Value (EMV) of the risk. EMV is a mathematical formula that can help make comparisons between a range of uncertain outcomes.
EMV = p x o
Where p = probability and o = outcome
For example a risk has a 75% chance of occurring and may cost £1k.
The EMV of the risk is:
0.75 x £1,000 so EMV = £750
Using the concept of EMV for comparative purposes suppose someone were to offer you two envelopes. Envelope A contains £1,000 and envelope B has a 50/50 chance of containing £2,500. Which would you choose? Looking at the EMV of each:
A is 100% certain so has a probability of 1 therefore
A = 1 x £1,000 EMV = £1,000
B has only a 50% chance of occurring therefore
B = 0.5 x £2,500 EMV = £1,250
In theory you should take envelope B as the EMV is higher. In practice your decision will depend on how badly you need the £1,000 and whether you are prepared to take a gamble. This goes back to the concept of Utility we discussed earlier.
Going back to our earlier example of the 10 week project, an accountant might say the expected cost of the project was:
Project budget + EMV of risk
Hence the project would cost £10k plus:
EMV = 0.5 x £2,000 = £1,000
A total of £11k.
This is fine in theory but in practice, if the risk occurred and you had a budget of £11k, you still wouldn't have enough to meet the cost of the risk.
