monetary value This is a topic that many people are looking for. daweaselonline.com is a channel providing useful information about learning, life, digital marketing and online courses …. it will help you have an overview and solid multi-faceted knowledge . Today, daweaselonline.com would like to introduce to you Expected Monetary Value (EMV) and Decision Trees. Following along are instructions in the video below:
“Form of quantitative risk. Analysis and modeling techniques is the expected monetary value. The abbreviation abbreviation for expected. Monetary.
Value is e n. V. Analysis. So.
What is the expected value. It s a statistical analysis. Which calculates the average outcomes of future scenarios. It helps me predict the value of each scenario should things go in a certain way for a certain situation and of course.
It helps me decide which way to go or which option to choose now a few few remarks about the monetary expected monetary value analysis is that it adopts a risk neutral assumption so it does not take into account. The risk factor. Here otherwise. It would be very complex and the way it works is by multiplying probability and impact values of the scenarios.
We will see an example in a minute. This is what is known as the decision trees so decision trees is the same as the expected monetary value analysis. Now the way we use it to make decisions is the emv of opportunities must be positive of course and we choose those if we have positive values the emv of threats will be displayed as negative values and we always choose the option with the higher expected monetary value so if i m talking about opportunities. I will be choosing the option with the higher positive value if i m talking about threats.
I will be choosing the option with the less lesser value because it s negative. So it s a mathematically a higher value because it has a negative sign. This is what a decision tree looks like i have a decision to make and i can go in two different directions..
I have two options or two scenarios to follow okay. So this is called the decision node as our decision. This is a decision node and these are chance nodes. And you can see that the probability of this node happening or this thing happening this chance.
Happening is 20. When the probability of this other chance happening is 80. And so on and i have the outcome node. Which will be calculated.
Let s take a look at an example with some numbers. So we understand this concept very well the decision tree or the expected monetary value analysis is very important and i have placed this exam. Tip for you to draw your attention to this first of all it comes frequently in pmi exams. Pmp and pmi rp.
And also it is really really really easy to answer correctly. Once you understand how to use it. So. Let s take a look at this example with some figures in order to correctly understand the concept.
Let s assume that i have a decision to make and the decision is to build a new factory or upgrade. The existing factory. Let s say i have a processing plant or a product production factory of some sort and i need to expand i need to increase my business and i have to make a decision some people suggested that i should build a new plant or others suggested that i should upgrade. The existing plant upgrade.
The existing machinery and equipment. Etc. Etc..
So how do i make. The decision. Let s quantify. It.
And that s why it is a tool and technique for quantitative risk analysis. So quantifying. This is done in this way. I need to estimate the cost of building.
A new plant so if i build a new plant. I will be investing an amount of 120 million dollars for example. How i come up with this estimate. I may use the three point estimate or some other way to estimate the cost it doesn t matter.
The point is i need to estimate how much this option is going to cost me on the other hand upgrading. The plant is expected to cost me an investment of 50 million dollars. Now we studied the market conditions. And we found that there is a 60 percent chance of having strong demand for my product.
Whatever product that this plant produces. So by studying the market condition. I found that there is a 60 percent chance of having strong demand and a 40 chance of having weak demand for my product notice guys that this comes from the market from the enterprise environmental factors. Which was an input to the perform quantitative risk analysis.
Now the market conditions will be the same for all choices. I cannot have different percentages here than here because these are based on market conditions. However these are based on the choices..
I make this is why i have a different amount of investment than what i have here okay now we have to estimate how much sales. I may make in case of a strong demand so in case of a strong demand and i am operating with a new plan. So i have built a new plant bigger and better and everything i expect to make sales of 200 million dollars. However in case of a weak demand and i have built a new plant.
I expect sales of 90 million dollars by the same token if i have upgraded my plant and keep in mind that upgrading the plant will give me a more limited capacity than building. A new plant. So the operation of the upgraded plant will be slightly the production rate. Our means will be slightly less and this is why in the case of a strong demand and i have upgraded the plant.
I expect to make sales of 120 million. Only in the case of weak demand for my product. I expect to make sales of 60 million dollars. Only now what is the value of the end node here okay.
The value is i have to subtract the expected amount from the node here minus the investment amount so the value of the end node is 200 million minus 120. Million gives me 80 million so basically the 80 million is my net profit in case of strong demand. I would have sold 200 million dollars. But i have invested 100 million 120 million dollars.
So my net profit would be 80 million in the same way i have to calculate the value of the end node in case of weak demand so i subtract 90 million minus 120 million. I get a value of negative 30 million so basically in case of weak demand. What this is saying is in case of weak demand. I would lose 30 million because my sales would be only 90 million.
But i have invested 120 million to build a new plant. So i would make a loss of 30 million dollars in the same way. I calculate the value of the end nodes of all the other branches and they come out as this the value of this end..
Node is 70 million and the value of this end. Node is 10 million. Now all i need to do is walk backwards in this decision. Tree and i need to multiply the value of the end nodes by their probability of occurrence because we estimated based on the market conditions that i have a 60 chance or probability of having a strong demand.
This means that generating 80 million dollars has a 60 probability. And having a loss of 30 million dollars has a 40 percent probability having 70 million dollars in case of a client upgrade also has a 60 probability. And so on keep in mind guys. That the these probabilities should be the same for every one of these options because they are related to the market conditions and not to the option.
We make so let s do that i multiply 80 million multiplied by 60 which is here and i add to it 30 million multiplied by 40 this gives me the value of this option. So if i choose this option. I get a value of 36 million dollars. I do the same for this option.
And i calculate its net value. I multiply 70 million by 60 and i add to it 40 multiplied by 10 million. I get a 46 million dollars. So which option is better for me.
According to this analysis. I choose the option with the higher e mv. So this is my preferred option. ” .
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