Analysing risk, capital budgeting and real options

5 important questions on Analysing risk, capital budgeting and real options

Accounting breakeven vs financial break even

Accounting- depreciation subtracted. Depreciation covers costs of recovering initial investment ( break even companies are losing money)

Limitations sensitivity analysis

Only allows one variable to change at time when likely that more variables change

Limitations Scenario analysis

Cant cover all sources of variability
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Monte carlo simulation

Attempt to make model of real world uncertainty
1. Determine basic model
2. Determine distribution for each variable in the model
3. Let computer draw 1 outcome
4. Repeat procedure
5. Calculate npv

Advantages monte carlo simulation

1. More complete than sensitivity analysis
2. Interaction effect between variables taken into account
3. Because of precision, better understanding of the project
4. Gives distribution of npv based on probability, provides more insight into npv

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