Expected value is a type of statistical analysis used in management to make business decisions. The concept of expected value assigns statistical probabilities to various outcomes within an event. By then comparing the expected value of different events, management can make better business decisions, including selection of the event that has the highest expected value.
Instructions
1. Calculate the expected value of Event A for a business. For example, assume a business wants to purchase new retail space and has three options, or events. Space A has a 40 percent probability of generating sales of $100,000 and a 60 percent probability of generating sales of $60,000. Multiply the probability of each occurrence by the expected result and add the sums. Continuing the same example, ($100,000 x .4) + ($60,000 x .6) = $40,000 + $36,000 = $76,000. This figure represents the expected value of moving to space A.
2. Calculate the expected value of Event B for a business. Space B has a 35 percent probability of generating sales of $85,000 and a 65 percent probability of generating sales of $75,000. Multiply the probability of each occurrence by the expected result and add the sums. Continuing the same example, ($85,000 x .35) + ($75,000 x .65) = $29,750 + $48,750 = $78,500. This figure represents the expected value of moving to Space B.
3. Calculate the expected value of Event C for a business. Space C has a 20 percent probability of generating sales of $110,000 and an 80 percent probability of generating sales of $50,000. Multiply the probability of each occurrence by the expected result and add the sums. Continuing the same example, ($110,000 x .2) + ($50,000 x .8) = $22,000 + $40,000 = $62,000. This figure represents the expected value of moving to Space C.
4. Evaluate the results. Look at the expected value of each option and make a management decision based on the outcome with the highest expected value. Continuing the same example, Space A has an expected value of $76,000, Space B has an expected value of $78,500, and Space C has an expected value of $62,000. Looking at the highest expected value, the business should purchase retail space B.
Tags: expected value, generating sales, percent probability, percent probability generating, probability generating, probability generating sales, expected value