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Expected Monetary Value Analysis

5 minutes 5 Questions

Expected monetary value analysis is a statistical technique in risk management that calculates the average outcome when the future includes scenarios that may or may not happen. This is essentially a mathematical expectation, a weighted average of all possible outcomes in terms of their probabiliti…

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CAPM - Expected Monetary Value Analysis Example Questions

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Question 1

You are working on a new product development project and there is a 0.4 probability that a key component will fail, causing a potential delay costing $175,000. What's the expected monetary value of this risk?

Correct Answer: $70,000

The expected monetary value of a risk is calculated by multiplying the probability of the risk by the cost of the risk. In this case, the probability that the key component will fail is 0.4 and the potential cost of this failure is $175,000. Therefore, by multiplying 0.4 by $175,000, we get $70,000. This means the expected monetary value of this risk is $70,000. The other answers are wrong because they do not result from this calculation. The answer $100,000 is higher than the calculated value, and the answers $200,000 and $250,000 are significantly higher than the calculated value.

Question 2

In a pharmaceutical research project, there's a 25% chance of discovering a breakthrough drug worth $10 million, and a 75% chance of the research yielding no significant results. What is the Expected Monetary Value (EMV) of this project?

Correct Answer: $2.5 million

The correct answer is $2.5 million. To calculate the Expected Monetary Value (EMV) of this project, we need to consider both the probability of success and the potential value of the outcome. Step 1: Identify the probabilities and values - Probability of success (discovering a breakthrough drug): 25% or 0.25 - Value of success: $10 million - Probability of failure (no significant results): 75% or 0.75 - Value of failure: $0 Step 2: Calculate the EMV EMV = (Probability of success × Value of success) + (Probability of failure × Value of failure) EMV = (0.25 × $10 million) + (0.75 × $0) EMV = $2.5 million + $0 EMV = $2.5 million The other answers are incorrect: $7.5 million is not correct as it does not consider the probability of failure and overestimates the value. $3.75 million is incorrect as it mentions factoring in research costs, which are not provided in the question and should not be included in the EMV calculation. $1.25 million is incorrect as it mentions adjusting for industry average success rates, which is not relevant to this specific project's EMV calculation.

Question 3

You are a project manager at a construction company, and it was discovered that there is a 0.2 probability that additional engineering studies will be required. These studies would potentially cost $200,000. What is the expected monetary value of the engineering studies?

Correct Answer: $40,000

The Expected Monetary Value (EMV) is a concept used in project management to quantify the risk associated with a particular event. It is calculated by multiplying the probability of an event occurring by the potential cost of that event. In this case, the probability of requiring additional engineering studies is 0.2 and the cost of these studies is $200,000. When you multiply these two together ($200,000 * 0.2), the result is $40,000. This means the expected value, or risk-weighted impact of the additional studies is $40,000. The other answers are incorrect because they do not result from applying this calculation.

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