How do you compute the expected monetary value (EMV) of an alternative?

How do you compute the expected monetary value (EMV) of an alternative?

• A. EMV equals the maximum payoff across scenarios
• B. EMV equals the expected value calculated as the sum of probability-weighted payoffs across all scenarios for that alternative
• C. EMV ignores scenario probabilities
• D. EMV is the minimum payoff across scenarios

Answer: (B)

The main idea is to evaluate an option by averaging its payoffs across all possible outcomes, weighting each payoff by how likely that outcome is. EMV is calculated as the sum of each scenario’s probability times the payoff in that scenario for that option. For example, if there are several outcomes with payoffs of 100, 40, and -20 and their probabilities are 0.2, 0.5, and 0.3 respectively, the EMV would be 0.2×100 + 0.5×40 + 0.3×(-20) = 20 + 20 − 6 = 34. This shows why the probability-weighted average is the right approach: it reflects not only the possible payoffs but also how likely each one is, giving a meaningful average result over many repetitions of the decision. The other ideas don’t fit because EMV isn’t just the best payoff (that would ignore probabilities), it isn’t the minimum payoff (that would focus on the worst case), and it isn’t a payoff that ignores scenario probabilities. EMV always combines both outcomes and their likelihoods to give the expected monetary value.

The main idea is to evaluate an option by averaging its payoffs across all possible outcomes, weighting each payoff by how likely that outcome is. EMV is calculated as the sum of each scenario’s probability times the payoff in that scenario for that option.

For example, if there are several outcomes with payoffs of 100, 40, and -20 and their probabilities are 0.2, 0.5, and 0.3 respectively, the EMV would be 0.2×100 + 0.5×40 + 0.3×(-20) = 20 + 20 − 6 = 34.

This shows why the probability-weighted average is the right approach: it reflects not only the possible payoffs but also how likely each one is, giving a meaningful average result over many repetitions of the decision.

The other ideas don’t fit because EMV isn’t just the best payoff (that would ignore probabilities), it isn’t the minimum payoff (that would focus on the worst case), and it isn’t a payoff that ignores scenario probabilities. EMV always combines both outcomes and their likelihoods to give the expected monetary value.