Excel-Based Monte Carlo Simulation as a Capital Budgeting Risk Management Tool

Monte Carlo simulation is a useful capital budgeting tool that allows the user to reflect the uncertainty associated with various cash now components. The output from the simulation consists of distributions of net cash flows, which can be used for decision-making and risk management. Unfortunately,...

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Bibliographic Details
Published in:Journal of financial education 2011-04, Vol.37 (1/2), p.101-128
Main Author: Rozycki, John
Format: Article
Language:English
Subjects:
Capital budgeting
Data tables
Descriptive statistics
FINANCE PEDAGOGY
Gaussian distributions
Histograms
Monte Carlo methods
Owner earnings
Random variables
Risk management
Standard deviation
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Summary:Monte Carlo simulation is a useful capital budgeting tool that allows the user to reflect the uncertainty associated with various cash now components. The output from the simulation consists of distributions of net cash flows, which can be used for decision-making and risk management. Unfortunately, Monte Carlo simulations are often implemented using specialized software, making them inaccessible to many students. Moreover, in using specialized software, students may perceive Monte Carlo simulation as a "black box." I demonstrate how to implement Monte Carlo simulation for a complex capital budgeting problem using Microsofi Excel (Excel) and three common distributions: normal, lognormal and uniform. No additional software is needed. Since the simulation is built by modifying an already-understood static capital budgeting worksheet, it is more likely that the simulation will be understood and used.
ISSN:0093-3961
2332-421X