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Expected Value

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Expected value (EV) : 

  • EV = the weighted (by probabilities) average of the possible outcomes.

  • In the context of NPV appraisal, EV can be deduced by either of two routes:

    • finding the EV of each input factor and then using the single EV of each factor in the NPV assessment; or

    • identifying the NPV and probability of occurrence for each of the possible outcomes for the project (probably an enormously large number, in practice) and then finding the weighted average of these.

  • Route 1 is much easier, but only the EV is known; information on the spread of possible results is not revealed.

  • Route 2 gives all of the results but in practice it can be impossible to cope with the volume of data.

  • EV can be helpful because it summarises a large amount of data into one value.

  • Problems of EV:

  • The averaging process hides information, e.g. on the NPV and probability of occurrence in the worst-case scenario.

  • The calculated EV could easily be a value that cannot actually occur.

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