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.