Incorporating Risk into Capital Budgeting Decisions Using Simulation

Monte Carlo simulation is one of a number of analytical techniques available to enable managers to assess the risks surrounding capital budgeting decisions. Although it is covered in most texts on financial management, surveys have for many years pointed to only limited use of the technique by practising managers making decisions about investment projects. Describes and analyses a simulation model utilizing facilities available to most managers. The model uses a macro to automate the simulation process and generate a frequency distribution of a project′s net present value. The model can be rapidly implemented, uses a large number of individual simulations to provide a reliable frequency distribution and aids managerial decision making by presenting managers with an easily understood perspective on the uncertainty surrounding an investment project.