May seem silly but I don’t understand how EV hides risk and is actually measuring uncertainity. After all it is using probabilities and probabilities are derived from past experiences so EV should be measuring risk.

Suppose one project will give a return of either 50 or 150, and another one will give a return of 90 or 110. The first one is more risky because there is a much bigger spread of possible returns. But if the probability in each case is 0.5, then both projects will have the same EV. Using EV’s to choose is ignoring the risk.

Confused with regards to the expect values, as before watching this I thought the probabilities relate to the uncertain outcome, i.e. the demand for normal sales, outside of the contract thus, I don’t understand why it wouldn’t be (400 x $5) x 0.2 PLUS the normal cost of the contract. Why are we multiplying the combined total by the probability of the demand for normal sales??

The probabilities do relate to the uncertain outcome. However, the total outcome (i.e. the total profit) is the contract amount plus the amount from normal sales. This total is uncertain because the amount from normal sales is uncertain.

You could get the result by simply adding the amount from the contract to the expected amount from the normal sales – the answer would be the same.

However since in exam questions, the examiner specifically asks for the table showing the total outcomes it is easier just to use those figures as I do in the lecture.

what is the difference of using expected values method for one-off desicion and repeated occurrences? i still not understand , eventhough i have watch the vid

addisanopacourage says

Hi John

I enjoyed this lecture, many thanks!

John Moffat says

Thank you for your comment 馃檪

Stephen says

Sir, what type of businesses would not be able to carry forward stock?

John Moffat says

Businesses producing prepared food is one example 馃檪

ruby748 says

Hi Sir.

May seem silly but I don’t understand how EV hides risk and is actually measuring uncertainity. After all it is using probabilities and probabilities are derived from past experiences so EV should be measuring risk.

John Moffat says

EV’s do not measure risk – they ignore risk.

Suppose one project will give a return of either 50 or 150, and another one will give a return of 90 or 110. The first one is more risky because there is a much bigger spread of possible returns. But if the probability in each case is 0.5, then both projects will have the same EV. Using EV’s to choose is ignoring the risk.

stxameh says

Confused with regards to the expect values, as before watching this I thought the probabilities relate to the uncertain outcome, i.e. the demand for normal sales, outside of the contract thus, I don’t understand why it wouldn’t be (400 x $5) x 0.2 PLUS the normal cost of the contract. Why are we multiplying the combined total by the probability of the demand for normal sales??

Thanks

John Moffat says

The probabilities do relate to the uncertain outcome. However, the total outcome (i.e. the total profit) is the contract amount plus the amount from normal sales. This total is uncertain because the amount from normal sales is uncertain.

You could get the result by simply adding the amount from the contract to the expected amount from the normal sales – the answer would be the same.

However since in exam questions, the examiner specifically asks for the table showing the total outcomes it is easier just to use those figures as I do in the lecture.

polyteknica says

Dear sir,

Are expected values risk neutral?

John Moffat says

Someone who makes a decision using expected values is risk neutral.

Ainul Asyikin says

what is the difference of using expected values method for one-off desicion and repeated occurrences?

i still not understand , eventhough i have watch the vid

John Moffat says

If it is just a one-off decision then the outcome will just be one of those in the table.

Only if it is a repeated decision each of the outcomes appears sometimes, will the average outcome be the expected value.