US CMA Part 2 · Chapter 8 · Question 13 of 15
Which statement best describes Monte Carlo simulation in capital budgeting?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: C) It repeatedly draws values for uncertain inputs from probability distributions to generate a distribution of possible NPVs
Explanation
Monte Carlo simulation assigns probability distributions to key variables, runs many trials with randomly selected values and produces a distribution of NPV outcomes, from which management can estimate the probability of a negative NPV. Risk-adjusted discount rates and certainty equivalents are alternative ways of incorporating risk.
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