What is Monte Carlo simulation?

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What is Monte Carlo simulation?


What is Monte Carlo simulation?

Explanation & AnswerSolution by a verified expert


Monte Carlo simulation is a risk assessment technique which is quite complex as compared to the sensitivity and the scenario analysis. In Monte Carlo simulation, the probabilities of different variables, their sensitivities and the correlation between the input variables are taken into consideration to determine the expected net present value (NPV) of a project.
Excel softwares is used to create a simulation wherein on random any one of the variables are changed and based on the probability and other inputs for that variable, the NPV is determined. Similarly, different values are changed and the NPV is determined. This process of finding the NPV is known as trials. Once different values of NPVs are determined, based on their respective probabilities, the expected NPV is finally determined.

Verified Answer

A risk assessment technique wherein the sensitivity, probability and correlation between different variables are taken to measure net present value (NPV) in different scenarios and finally computing the expected NPV is known as the Monte Carlo simulation.

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