Unformatted text preview: eable approach to changing two or more factors at the
same time is computer simulation. Simulation analysis is the analysis of cash flows and returns on
investments when more than one uncertain element is considered (allowing more than one probability
distribution to enter the picture). Simulation analysis allows the financial manager to develop a probability
distribution of possible outcomes, given a probability distribution for each variable that may change.
Simulation analysis is more realistic than sensitivity analysis because it introduces uncertainty for many
variables in the analysis. But if you use your imagination, this analysis may become complex since there
are interdependencies among many variables in a given year and interdependencies among the variables
in different time periods.
However, simulation analysis looks at a project in isolation, ignoring the diversification effects of projects,
focusing instead on a single project's total risk. And simulation analysis also ignores the effects of
diversification for the owners' personal portfolio. If owners hold diversified portfolios, then their...
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- Spring '07