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you need to:

1. Assign a probability of occurrence for the risk.

2. Assign monetary value of the impact of the risk when it occurs.

3. Multiply Step 1 and Step 2.

The value you get after performing Step 3 is the Expected Monetary

Value. This value is positive for opportunities (positive risks) and

negative for threats (negative risks). Project risk management requires

you to address both types of project risks.

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Suppose you are leading a construction project. Weather, cost of

construction material, and labor turmoil are key project risks found in

most construction projects:

Project Risks 1 - Weather: There is a 25 percent chance of excessive

snow fall thatll delay the construction for two weeks which will, in

turn, cost the project $80,000.

Project Risks 2 - Cost of Construction Material: There is a 10

percent probability of the price of construction material dropping,

which will save the project $100,000.

Project Risks 3 - Labor Turmoil: There is a 5 percent probability of

construction coming to a halt if the workers go on strike. The impact

would lead to a loss of $150,000. Consider your industry and

geographic area to determine whether this risk would have a higher

probability.

Note: Regardless of the type of project, the golden rules of project risk

management do not change. Hence, though this example is from the

construction industry , the theory is applicable to other industries, such

as software development and manufacturing.

Next, let's see how to quantify the project risks by calculating the

Expected Monetary Value of each risk.

Expected Monetary Value Calculation for Project Risk

Management

In this Expected Monetary Value example, we have two negative project

risks (Weather and Labor Turmoil) and a positive project risks (Cost of

risks:

Weather: 25/100 * (-$80,000) = - $ 20,000

Cost of Construction Material: 10/100 * ($100,000) = $ 10,000

Labor Turmoil: 5/100 * (-$150,000) = - $7,500

Note: Though the highest impact is caused by the Labor Turmoil project

risk, the Expected Monetary Value is the lowest. This is because the

probability of it occurring is very low.

This means that if the:

Cost of Construction Material positive project risks occurs, the

project gains $10,000, and

Labor Turmoil negative project risks occurs the project loses $ 7,500

The projects Expected Monetary Value based on these project risks is:

-($20,000) + ($10,000) ($7,500) = - $17,500

Therefore, if all risks occur in the construction project, the project would

lose $17,500. In this scenario, the project manager can add $17,500 to the

budget to compensate for this. This is a simplistic Expected Monetary

Value calculation example. Another technique used to calculate complex

Expected Monetary Value calculations is by conducting Decision Tree

Analysis. This analysis helps while making complex project risk

management decisions. For more details, read this article on Using a

Decision Trees Example in Project Risk Management to Calculate

Expected Monetary Value.

As a project manager, you may apply different production techniques to

minimize risk. For example, if this example was based on software

development or manufacturing, the project manager could use Lean

thinking to reduce waste and minimize risk. However, the method for

computing Expected Monetary Value during project risk management

would notchange .

This is our 26th post in our new learning series: PMP Concepts

Each post within this series will present a comparison of common concepts that appear on the PMP and CAPM

exams.

Sensitivity Analysis versus Expected Monetary Value (EMV)

There are two techniques used in quantitative risk analysis: a sensitivity analysis and an expected monetary value

(EMV) analysis.

Sensitivity Analysis

A sensitivity analysis determines which risks have the most potential impact on the project.

Sensitivity charts are used to visualize impacts (best and worst outcome values) of different uncertain variables over

their individual ranges.

A tornado diagram is a type of sensitivity chart where the variable with the highest impact is placed at the top of the

chart followed by other variables in descending impact order.

Expected Monetary Value (EMV)

Expected monetary value (EMV) analysis is a statistical concept that calculates the average outcome when the future

includes scenarios that may or may not happen. An EMV analysis is usually mapped out using a decision tree to

represent the different options or scenarios.

EMV for a project is calculated by multiplying the value of each possible outcome by its probability of occurrence and

adding the products together.

Example

For a sensitivity analysis, the project risks are evaluated based on the potential financial impact of each individual risk

and then placed in rank order.

For an EMV analysis, you are evaluating two vendors:

Vendor A has a 50% probability of being on-time, a 30% probability of being late at an additional cost of $40,000 and

a 20% probability of delivering early at a savings of $20,000.

EMV: (30% x $40,000) + (20% x -$20,000) = $12,000 + ($4,000) = $8,000

Vendor B has a 30% probability of being on-time, a 40% probability of being late at an additional cost of $40,000 and

a 30% probability of delivering early at a savings of $20,000.

EMV: (40% x $40,000) + (30% x -$20,000) = $16,000 + ($6,000) = $10,000

Based on the EMV, Vendor A would be a better choice as the potential cost is lower.

Summary

Two common quantitative risk analysis techniques are sensitivity and expected monetary value (EMV) analyses.

A sensitivity analysis ranks risks based on their impact (usually in a tornado diagram) and an EMV analysis quantifies

the potential outcomes of risk scenarios (usually using a decision tree).

PMP CONCEPT 27: Deming vs Juran vs Crosby

Return to PMP Learning Concepts Home

(EMV)

Expected monetary value (EMV) is a ballpark figure that shows how much money a plaintiff canreasonably expect in mediation. Think

of it as an average of the best- and worst-case scenarios. It accounts not only for the dollar figure assigned to each outcome but also

for the likelihood of that outcome occurring.

To calculate EMV, multiply the dollar value of each possible outcome by each outcomes chance of occurring (percentage), and total

the results.

For example, if you bet $60 that Ill roll a die and itll come up on the number 4, the EMV is $40, because you have a 1 in 6 chance of

winning $60 and a 5 in 6 chance of losing $60:

If you had the choice of which bet to make, youd be wise to listen to the EMVs and opt for the coin flip.

As you may expect, EMVs get more complicated when you toss in a string of multiple outcomes. Heres an example from John

DeGroote. It starts with the decision tree shown here. (The values include attorney fees, and $124,000 represents the EMV for no

settlement.)

A decision-tree program generated the tree and already calculated the EMV for the no settlement outcome, but youre probably

wondering how it came up with that number. To calculate the EMV for the no settlement, start on the far right, where the plaintiff has a

30 percent chance of winning a $250,000 judgment, 60 percent chance for $350,000, and 10 percent chance for $650,000:

(.30 x $250,000) + (.60 x $350,000) + (.10 x $650,000) =

$75,000 + $210,000 + $65,000 = $350,000

Now, you must multiply that by the 50 percent chance that the plaintiff wins the verdict half of $350,000 is $175,000.

The EMV for the defendants verdict is 50 percent of $150,000, or $75,000.

Add the EMVs for the defendant and plaintiff: $175,000 for the plaintiff plus $75,000 for the defendant gives you $250,000. Because

the summary judgment denied outcome has a 40 percent chance of occurring, multiply the $250,000 by .40 to get $100,000.

The EMV for summary judgment granted is 60 percent of $40,000, which comes to $24,000.

Total the EMV for summary judgment granted and summary judgment denied, and you get $100,000 + $24,000 = $124,000, which

represents the EMV for no settlement.

This EMV is likely to give the client a new perspective, especially if the client is the plaintiff whos convinced of winning a settlement of

$650,000. Compared to an EMV of $124,000, a much lower sure-thing settlement of, say, $300,000 looks much more attractive.

Monetary Value

These are one of the techniques used when carrying out the process perform quantitative risk analysis, and is used as the

first step in determining the uncertainties within the project in all of to get better information upon which to make a

judgment.

This technique will normally occur by using subject matter experts all people with experience with this type of project.

The focus here will be on the determining those risks that may impact upon schedule or cost of the project.

The Decision Tree analysis will enable you to make better decisions, and to determine the most appropriate actions for

both risk threats and opportunities and hence assist in the Plan Risk Responses process.

The decision tree technique is there to establish a costs order point that based on various risk scenarios, so the decision

tree needs to be drawn up correctly and logically.

The best way to do this is to arrange a meeting or workshop so that the various risk scenarios can be brainstormed and

probability of the scenario estimated. From the list, the monetary value must be determined that is associated with each

outcome by multiplying the risk probability times the monetary value of each outcome.

The monetary value of the Decision Tree risk outcomes can now be added to get the expected monetary value of the risk

of decision.

Dave owns a condo in the Far East and is considering buying a new apartment in Italy, but his wife would rather spend

the money on modernizing their current condo.

Dave had previously considered modernizing your condo, but purchasing or importing modern furniture in your city has

been a problem in the Far East.

Remodelling costs of the condo if new furniture and fittings are available will cost $ 45,000, but there is a 50/50 chance

that the furniture is not available locally and will need to be imported which will then cost $65,000.

Dave has found an old townhouse in Naples but it will need a lot of work to make it habitable. The price is $ 105,000. He

has found a local builder and he has given you a best case cost of $55,000 and a worst case cost of $75,000. The builder

advises that the best case is 60% likely.

Dave expects to get $160,000 for the sale of his condo, and now needs to discuss the possible outcomes with his wife.

Draw a decision tree and calculate the Net Path Value (Expected Monetary Value).

Laying out this scenario as a Decision Tree with the various outcomes might look like this:

So once you have the Decision Tree drawn, it is fairly straightforward to calculate the numbers.

Take the assumption of the furniture being available for purchase, this is 50% likely to happen and if it did it would cost

$45,000. So the math is just 0.5 times $45,000 = $22,500.

Summing the EMV for the refurbish condo option gives $57,000, and similarly for the move to Italy, gives $63,000.

Notice that the selling and buying of the properties have not been factored in here for simplicity.

In the real world, this would need to have other factors added, such as the cost of selling and buying, the likely market

situation to do that, the time frames involved and so on. However, this example is typical of a PMP exam question.

- See more at: http://www.pm-primer.com/decision-tree-risk-analysis/#sthash.XhQooHgU.dpuf

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