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Simulation analysis is the analysis of cash flows and

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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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