Suppose that your organization is deciding which of four projects to bid on, as
ID: 3703544 • Letter: S
Question
Suppose that your organization is deciding which of four projects to bid on, as summarized in the table below. Assume that all up-front investments are not recovered, so they are shown as negative profits. Calculate the EMV for each project. Explain which projects you would bid on and why. Use the EMV and your personal risk tolerance to justify your answer.
Project Chance of Outcome Estimated Profits Project 1 50% $100,000 50% -$30,000 Project 2 30% $145,000 40% $40,000 30% -$70,000 Project 3 70% $40,000 30% -$15,000 Project 4 30% $50,000 30% $20,000 20% $10,000 20%Explanation / Answer
Answer:
I am considering this formation for caculating the EMV.
Probability (P)*Outcome= EMV
Now taking the projects' data to evaluate EMV, we have
Project 1
P=0.50*$100,000=$ 50,000
Decision
P=0.50*-$ 30,000=-$15,000
Project 2
P=0.30*$145,000=$43,500
P=0.40* $40,000=$16,000
Decision
P=0.30*-$70,000=-$21,000
Project 3
P=0.70*$40,000=$28,000
Decision
P=0.30*-$15,000=-$4500
Project 4
P=0.30 $50,000=$15,000
P=0.30 $20,000=$6,000
P=0.20 $10,000=$2,000
Decision
P=0.20 -$0=-$0
Project 1’s EMV=$ 50,000-$15,000=$35,000
Project 2’s EMV=$43,500+$16,000-$21,000=$38,500
Project 3’s EMV=$28,000-$4500=$23500
Project 4’s EMV=$15,000+$6,000+$2,000-$0=$23,000
Based on the above diagram, I think project 2 I would bid on, because the EMV provides an estimate for the total dollar value of a decision, I want to have a positive number, the higher the EMV, the better project should be.
Also, If I just looked at the potential outcome of the 4 projects, project 2 looks more appealing. It could earn $185,000 in profits from project 2, but it can only earn $100,000 for project 1. However, there is only a 50 percent chance of getting that $100,000 on project 1, and there is a 70 percent chance of earning $185,000 on project 2. Therefore, using this EMV calculations, Project 2 will be the best option for bid on.
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