Page 1 of 8
Fundamentals of Decision Making
Using EMVs, EOLs, and EVPIs to Make Choices in Business
I. Decision theory – An analytic and systematic approach to solving problems. Just like
quantitative analysis, decision theory has its own set of steps:
A. Define the problem.
B. List the possible alternatives.
C. Identify the possible outcomes.
D. List the payoff of each combination of alternatives and outcomes.
E. Select one of the mathematical decision theory models.
F. Apply the model and make a decision.
II. Let’s look at one of these decisions in action: THIS IS NOT HOMEWORK: It is only an example.
A. Define the problem. Maria wants to set up a dress shop in a vacant space at the local mall.
B. List the possible alternatives. She can set up a small shop, a medium shop, or no shop.
C. Identify the possible outcomes. Maria believes that there are three possible outcomes: a
good economy, a fair economy, and a poor economy.
1. Remember: It is important to consider all possible outcomes. Ignoring outcomes—bad
or good—can do considerable damage to the decision-making process.
D. List the payoff of each combination of alternatives and outcomes. Maria maps out all
outcomes in terms of profits, but other outcomes can be used. This is what she finds:
Good Market Fair Market Poor Market
Small Shop $75,000 $25,000 -$40,000
Medium Shop $100,000 $35,000 -$60,000
No Shop $0 $0 $0
1. If Maria chooses to build a small shop and the market is good, she makes $75,000.
2. If Maria chooses to build a medium shop and the market is poor, she loses $60,000.
3. If Maria chooses to do nothing, she neither gains nor loses money ($0).
4. Etc.
E. Select one of the mathematical decision theory models and decide. This is where Maria has
choices to make, some of which are dependent upon what she wants and what she knows.
, Page 2 of 8
Decision-Making Tool 1: The Expected Monetary Value (EMV)
One tool that Maria can use to help her decide is the Expected Monetary Value, or EMV.
▪ Simply put, the EMV helps weigh the risks and rewards of each choice to make the best
possible decision.
▪ To do this, the EMV weighs the possible benefits of each decision with the chance of each
event happening.
Let me show you how the EMV works with Maria’s situation.
A. To do an EMV, Maria needs two things:
1. The grid we built on page 2, and
2. The odds of how good the economy is going to be over the next year.
B. Let’s suppose Maria knows the odds of the economy going different directions over the next
year (for information on how decision-makers get this information, ask your instructor):
1. First, the chance of a good economy is 20%.
2. Second, the chance of a fair economy is 50%.
3. Third, the chance of a poor economy is 30%.
C. She can use this knowledge to decide about what kind of shop to build. Here’s how, step by
step:
How to construct an EMV:
Step 1: Build your grid (like Maria’s, below) and include amounts that could be gained or lost
(numbers in blue), as well as the probabilities of each economy happening (numbers in red).
Good Economy Fair Economy Poor Economy
Small Shop $75,000 $25,000 -$40,000
Medium Shop $100,000 $35,000 -$60,000
No Shop $0 $0 $0
Probabilities 20% 50% 30%
Fundamentals of Decision Making
Using EMVs, EOLs, and EVPIs to Make Choices in Business
I. Decision theory – An analytic and systematic approach to solving problems. Just like
quantitative analysis, decision theory has its own set of steps:
A. Define the problem.
B. List the possible alternatives.
C. Identify the possible outcomes.
D. List the payoff of each combination of alternatives and outcomes.
E. Select one of the mathematical decision theory models.
F. Apply the model and make a decision.
II. Let’s look at one of these decisions in action: THIS IS NOT HOMEWORK: It is only an example.
A. Define the problem. Maria wants to set up a dress shop in a vacant space at the local mall.
B. List the possible alternatives. She can set up a small shop, a medium shop, or no shop.
C. Identify the possible outcomes. Maria believes that there are three possible outcomes: a
good economy, a fair economy, and a poor economy.
1. Remember: It is important to consider all possible outcomes. Ignoring outcomes—bad
or good—can do considerable damage to the decision-making process.
D. List the payoff of each combination of alternatives and outcomes. Maria maps out all
outcomes in terms of profits, but other outcomes can be used. This is what she finds:
Good Market Fair Market Poor Market
Small Shop $75,000 $25,000 -$40,000
Medium Shop $100,000 $35,000 -$60,000
No Shop $0 $0 $0
1. If Maria chooses to build a small shop and the market is good, she makes $75,000.
2. If Maria chooses to build a medium shop and the market is poor, she loses $60,000.
3. If Maria chooses to do nothing, she neither gains nor loses money ($0).
4. Etc.
E. Select one of the mathematical decision theory models and decide. This is where Maria has
choices to make, some of which are dependent upon what she wants and what she knows.
, Page 2 of 8
Decision-Making Tool 1: The Expected Monetary Value (EMV)
One tool that Maria can use to help her decide is the Expected Monetary Value, or EMV.
▪ Simply put, the EMV helps weigh the risks and rewards of each choice to make the best
possible decision.
▪ To do this, the EMV weighs the possible benefits of each decision with the chance of each
event happening.
Let me show you how the EMV works with Maria’s situation.
A. To do an EMV, Maria needs two things:
1. The grid we built on page 2, and
2. The odds of how good the economy is going to be over the next year.
B. Let’s suppose Maria knows the odds of the economy going different directions over the next
year (for information on how decision-makers get this information, ask your instructor):
1. First, the chance of a good economy is 20%.
2. Second, the chance of a fair economy is 50%.
3. Third, the chance of a poor economy is 30%.
C. She can use this knowledge to decide about what kind of shop to build. Here’s how, step by
step:
How to construct an EMV:
Step 1: Build your grid (like Maria’s, below) and include amounts that could be gained or lost
(numbers in blue), as well as the probabilities of each economy happening (numbers in red).
Good Economy Fair Economy Poor Economy
Small Shop $75,000 $25,000 -$40,000
Medium Shop $100,000 $35,000 -$60,000
No Shop $0 $0 $0
Probabilities 20% 50% 30%
