CIMA P2 Syllabus D. Risk and Control - Probability Analysis - Notes ^{4 / 13}

This gives potential outcomes a probability

These probabilities are then used to calculate an expected net present value (ENPV)

Formula

∑px
P = probability and X = Value of outcome
It finds the the long run average outcome rather than the most likely outcome

A new product cashflows will depend on whether a substitute comes onto the market or not

Chance of substitute coming in 30% - this will lead to a loss of (10,000)
NPV with no substitute though is 20,000
Solution
Subsitute does come in = 0.3 x (10,000) = (3,000)
Subsitute does NOT come in =0.7 x 20,000 = 14,000
ENPV = 11,000

Expected values are more useful for repeat decisions rather than one-off activities, as they are based on averages.

They illustrate what the average outcome would be if an activity was repeated a large number of times.

A long term rather than short term average

For example the expected value when throwing a dice is 3.5!
And the average family in the UK has 2.4 children, now I've never thrown a 3.5 nor met anyone with 2.4 children.
These are just long term averages, whereas in reality outcomes only occur once