EXPECTED LOSS PROBABILITIES

Question 1

Winterfell Partners completed an enterprise risk assessment and has identified four risks. They’ve continued to note the significance, likelihood, and cost impact of occurrence of each of the four risks:

Risk 1: Significance = 0.1, Likelihood = 0.1, Cost Impact = $1,275,000
Risk 2: Significance = 0.2, Likelihood = 0.8, Cost Impact = $600,000
Risk 3: Significance = 0.3, Likelihood = 0.7, Cost Impact = $700,000
Risk 4: Significance = 0.6, Likelihood = 0.6, Cost Impact = $800,000

Which of the identified risks has the lowest expected value of cost?

Source: CMA Coach Academy, 2021

Answer 1

The expected value of cost is calculated as the product of the significance, the likelihood of a risk being incurred, and the estimated cost impact. In this example, Risk 4 has the highest risk score of 0.36 (0.6 × 0.6 = 0.36) and highest expected value of cost at $288,000 (0.36 × $800,000), while Risk 1 has the lowest risk score (0.1 × 0.1 = 0.01) and the lowest expected value of cost at $12,750 (0.01 × $1,275,000).

Short Answer:

1. Use calculation: Significance x Likelihood x Cost Impact
2. Direct relationship: As expected value of cost INCREASES, Risk INCREASES