Beginning With a Qualitative Risk Analysis…
After conducting a Qualitative Risk Analysis, you’ll have a list of risks with a priority and urgency assigned. By using Expected Monetary Value, you can quantify each risk to determine whether your qualitative analysis is backed by numbers. Expected Monetary Value is a recommended tool and technique for Quantitative Risk Analysis in Project Risk Management. For the PMP exam, you need to know how to create an EMV calculation.
Steps to Calculate Expected Monetary Value (EMV)
To calculate the EMV in project risk management, you need to:
- Assign a probability of occurrence for the risk.
- Assign monetary value of the impact of the risk when it occurs.
- 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.
EMV Calculation Example
[caption id=“attachment_132897” align=“aligncenter” width=“640”] Risk management should include monetary estimates[/caption] 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 that’ll 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.
Performing the Calculation
In this Expected Monetary Value example, we have two negative project risks (Weather and Labor Turmoil) and a positive project risks (Cost of Construction Material). The Expected Monetary Value for the project 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:
Weather negative project risks occurs, the project loses $20,000,
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 project’s 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 EMV 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 EMV. 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 not change.