cbrisk_2

A common approach is to use a measure of central

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Unformatted text preview: each possible outcome with this one value. A common approach is to use a measure of central location of a probability distribution, the expected value. Let's use N to designate the number of possible future outcomes, xn to indicate the nth possible outcome, pn to indicate the probability of the nth outcome occurring, and E (x) to indicate the expected outcome. The expected cash flow is the weighted average of the cash flows, where the weights are the probabilities: E(x) = x1p1 + x2p2 + x3p3 +...+ xnpn + ... + xNpN Expected value = E (x) = N ∑ pn xn n=1 Capital budgeting & risk, a reading prepared by Pamela Peterson Drake 4 The standard deviation is a measure of how each possible outcome deviates -- that is, differs -- from the expected value. The standard deviation provides information about the dispersion of possible outcomes because it provides information on the distance each outcome is from the expected value and the likelihood the outcome will occur. The standard deviation is: Standard deviation of possible outcomes = σ(x) = N ∑ pn (xn − ε(x))2 n =1 We begin our calculation of standard deviatio...
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