Project Management

Estimated Monetary Value for Risk Management

This is a process concerned with identifying, analyzing, and responding to project risk. (PMBOK)

It is also the art and science of identifying, assessing and responding to project risk throughout the life of a project and in the best interests of its objectives. Now in all of the projects I’ve managed in my 30 years of experience, there has always been risk.

 

The trick to the game is to figure out what the risk tolerance of your stakeholders is. How much risk are they willing to put up with and how much do they want solid fallback plans for?

In some cases, a level of uncertainty is acceptable and the level of contingency planning can be as simple as put another person on the project, or slip the schedule.

 

Sometimes it’s not so simple, and the stakeholders want to know the monetary value or expected value of the probability of a risk occurring. The basic level for excepted value is:

 

Expected monetary value (EMV) = probability * impact

 

The expected value result can either be added to the costs of the project or subtracted from the project’s profit. The project profit or cost is usually referred to as the baseline. The baseline is the initial approved cost or profit structure for the project.

 

Project EMV = project cost + risk expected value – opportunity expected value

                                    -Or-

                                 = project value/profit – risk expected value + opportunity expected value

 

Remember, risk increases the cost and decreases the profit; and opportunity increases the profit and decreases the cost. Risks are bad things that may (often do) happen to us on projects, sometimes expressed as “threats”. Opportunities are good things that may happen to us on projects and may enhance the overall situation.

 

With that in mind, let’s work through a few examples.

 

Example: You have a project with total planned costs of $100,000. What information of value to an expected monetary analysis do you have so far? The baseline ($100,000). Now with that bit of information, let’s add some more considerations and complexity to it. For this same project, with total planned costs of $100,000, there is a risk that one of your team members, Matthew, will be crowned Prince of Arabia! If that happens, we’ll lose $8,000 in the process of replacing him on the team.  Now what new information do you have that helps you out? You have the Risk Impact ($8000).

After checking with highly placed sources within Arabia, we have learned that there is about a 60% chance that Matthew will be approved as the new Prince. What new information do we have now? We have the probability (60%).

Now for this project we know that the cost is $100,000, and there is a 60% chance we’ll lose Matthew, costing the project $8000. What is the Expected Value of this risk happening to our project? In this instance, we are looking at the expected value of the risk. It has a potential cost of $8000. But, since the probability of it happening is only 60%, its EMV = $8000*.6 = $4800. We have now calculated the EMV for this risk event. We have to apply the EMV in the context of the project as a whole. What is the EMV of the cost of the whole project? The answer is $104,800 ($100,000 + $4,800).

We also need to consider any opportunities which may offset the cost of the risk. For this project, in addition to the potential concerns of Matthew’s leaving, we have just received some good news! We may have the opportunity of a bonus from the customer, which would reduce costs by $20,000. The chance of us getting the bonus is 30%. What is the expected value of this chance? It is $6000, 30%*$20,000. Are you still with me here?

Now we have a lot more information for the stakeholders. The project will cost $100,000. There is a risk of losing Matthew at an additional cost of $8000, but there is only a 60% chance of that occurring. There is also an opportunity for a bonus of $20,000, with a chance of 30% of that occurring. With all of these considerations, what is the Expected Monetary Value of this Project? It is $98,800. This is calculated by taking the cost baseline of $100,000 + $4800 (risk of losing Matthew) and subtracting the EMV of the opportunity because it will affect our costs. That is $6000. So the total Expected Monetary Value of this project is $98,800.  That incorporates both known risks and opportunities.

For our project we now have a new perspective. Nancy from accounting finally came through with the numbers on how we are expected to profit from the project. Specifically, she was able to establish that the project will yield about $210,000 in revenues. That will be offset by the cost of $100,000, but management is asking for a risk analysis. To review, what is the baseline profit of the project? It is $110,000 ($210,000 – $100,000).

Next we need to take into account the risk of losing Matthew which would increase cost by $8000. There is also an opportunity of a bonus that will increase revenues. Let’s list our information:

·         The project has a cost baseline of $100,000

·         Revenues are anticipated at $210,000

·         There is a 60% chance we’ll lose Matthew at a cost of $8000

·         There is a 30% chance we’ll earn a bonus of $20,000

·         For a few kickers, there is a 10% chance we’ll hit obstacles increasing costs by $30,000

·         There’s a %70 chance we’ll have a legal fight costing $10,000

With all of this new data, what is the new EMV? It is $100,000 (baseline cost) – $4800 ($8000 * %60) + $6000 ($20,000*30%)-$3000 ($30,000* %10) – $7000 ($10,000*70) = $101,200

 

So from a risk perspective, this project is worth doing.

 


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September 17, 2008 - Posted by | Risk Management |

3 Comments »

  1. Hello Ms. Donna Ritter
    I’m a Computer Science student and I’m having my final project and it so happen that your idea for monetary value for risk management is my topic. I would like to ask for your cooperation regarding my thesis, if it’s ok with you since I believe you have the experiences which can help me with my study. Please do email me or give me your email so that we can communicate from time to time about my study. Thanks and more power to you! ^__^

    Comment by hatahari | November 23, 2008 | Reply

  2. i am also doing a corporate project on this subject. let me know your thoughts.
    i am looking for better methods to evaluate “hyper-long term” investment projects and the risk of long-delayed future cash flows versus heavy upfront investments.
    thanks,
    se
    tampa, fla

    Comment by Steve | December 22, 2008 | Reply

    • I will look into my library and get back to you with an answer after the Holidays. Have a Merry Christmas and a Happy New Year!

      Comment by Donna Ritter | December 22, 2008 | Reply


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