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- [Instructor] When you analyze business scenarios,
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you will often want to calculate
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the expected value of an overall scenario
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with multiple possible outcomes.
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As an example, you might think that there would be
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three scenarios and you have assigned probabilities
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to each of them.
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So the first scenario you believe is 30% likely,
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the second scenario is 40%, and the third, 30%.
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Each of those scenarios will lead to a value, or outcome.
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So in scenario one, the value is $5,000, positive 5,000,
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for scenario two, it's 10,000,
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and for scenario three, that you would have
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a loss of $10,000.
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You can then calculate the expected value
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for each of these scenarios.
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To do that, you multiply the probability by the value.
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So the expected value for scenario one,
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which is 30% likely with a $5,000 value,
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is 30% times 5,000 equals 1,500.
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You can use the same calculations
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to calculate expected value for scenario two of 4,000
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and scenario three of minus 3,000.
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You then add up all the expected values
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to get the overall expected value for a scenario.
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So that would be 1,500 plus 4,000
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minus 3,000 equals positive $2,500.
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So if you're evaluating an investment,
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this appears to be a good way to spend your money
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unless you can find something better to do.
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Now, let's switch over to Excel
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so that we can see how to implement this in a worksheet.
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I have switched over to my Excel sample file
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and that is 06_03_Expected Value.
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You can find it in the Chapter Six folder
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of the exercise files collection.
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Here, I have three scenarios
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and I have assigned different probabilities
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and values to them.
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You can see the probabilities in column B
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and the values in column C.
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And as noted in the first part of this video,
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I want to multiply the probability by the value
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of a particular scenario to get its expected value.
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So I will select cell D2,
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type an equals sign, and I'll multiply B2,
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the probability of scenario one,
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by the value in C2, which is the value,
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and I'll press Enter.
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And I see the expected value of scenario one, $50,000,
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with a 25% probability is $12,500.
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Now I will use the fill handle
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to drag the contents of cell D2
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so that it covers D3 and D4
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and I get those calculations there.
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So I have 60% times minus 25,000 equals minus 15,000.
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And then for scenario three, 15% times 14,000 is 2,100.
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Now to calculate the total expected value
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for this business proposition,
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I can click in cell B5 and I'll create an AutoSum formula.
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So I'll press alt-equal,
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I get SUM D2 to D4 and Enter,
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and I see that I have an expected value of minus $400.
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So that means according to my estimates,
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I am likely to lose money on this investment
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and I should not go ahead with it.
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