Expected Value

Expected value is a statistical concept that can be utilized to make better business decisions. The expected value is the anticipated value of a given investment, scenario, or outcome. It is calculated by multiplying each possible outcome by the likelihood of that outcome occurring and then adding up those results. As a basic example, imagine a six-sided die, with values of 1 through 6. If a person rolls the die, the probability of each side landing face-up is one-sixth. To find the expected value of a single roll, multiply each outcome by its probability and sum them:(1/6) x 1 + (1/6) x 2 + (1/6) x 3 + (1/6) x 4 + (1/6) x 5 + (1/6) x 6 = 3.5. With equally likely outcomes, the expected value is the average of all values. Business owners can use this concept to make decisions about which projects to pursue. A higher expected value means a better project.

For example, imagine the following two projects:

Project A: 10% chance of making \$100,000, 40% chance of making \$20,000, 50% chance of making \$15,000

Project B: 10% chance of making \$175,000, 40% chance of making \$15,000, 50% chance of making \$5,000

The expected values are calculated as:

Project A (EV) = (0.1 x \$100,000) + (0.4 x \$20,000) + (0.5 x \$15,000) = \$25,500

Project B (EV) = (0.1 x \$175,000) + (0.4 x \$15,000) + (0.5 x \$5,000) = \$26,000

Project B has the higher expected value and should be chosen.

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