CS Professional · Strategic Management and Corporate Finance · Project Evaluation
Which technique in capital budgeting uses probability distributions of input variables, repeatedly draws random values for them, and generates a distribution of project NPV or IRR?
Simulation analysis, commonly Monte Carlo simulation, does this. It repeatedly draws random values from the probability distributions of key variables like price, volume and cost, and builds a distribution of possible NPV or IRR outcomes for the project.
- APayback reciprocal method
- BSimulation analysis (Monte Carlo)Correct
- CBreak-even analysis
- DProfitability index method
Explanation
Monte Carlo simulation randomly samples from the probability distributions of variables such as price, volume and cost over many runs, producing a distribution of NPV or IRR. The other methods do not generate such distributions.
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