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Risk and Uncertainty

Example 2

An organisation is considering launching a new product. It will so if the
expected value of the total revenue is in excess of $1,000. It is decided to set
the selling price at $10. After some investigation a number of probabilities for
different levels of sales revenue are predicted; these are shown in the
following table:

Units sold Revenue Probability Payoff
$ $

80 800 0.15 120
100 1,000 0.50 500

120 1,200 0.35 420
1.00 EV = 1,040

The expected sales revenue at a selling price of $10 per unit is

$1,040, that is [800 × 0.15] + [1,000 × 0.50] + [1,200 × 0.35].

In preparing forecasts and making decisions management may proceed on
the assumption that it can expect sales revenue of $1,040 if it sets a selling
price of $10 per unit.

The actual outcome of adopting this selling price may be sales revenue that is
higher or lower than $1,040. And $1,040 is not even the most likely outcome;
the most likely outcome is $1,000, since this has the highest probability.

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