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Chapter 9: Simulation
Concepts and Methods
Project risk analysis by
simultaneous adjustment
of forecast values.
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Introduction
Simulation allows the repeated
solution of an evaluation model.
Each solution randomly selects
values from predetermined
probability distributions.
All solutions are summarized into
an overall distribution of NPV
values.
This distribution shows
management how risky the project
is.
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Simulation Terminology
The treatment of risk by using simulation
is known as ‘stochastic’ modeling.
Other names for our term ‘Simulation’,
are - ‘Risk Analysis’, ‘Venture
Analysis’,’Risk Simulation’, ‘Monte Carlo
Simulation’.
The name ‘Monte Carlo Simulation’
helps visualization of repeated spins of
the roulette wheel, creating the selected
values.
Each execution of the model is known as
a ‘replication’ or ‘iteration’.
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The Role of Simulation
Follows the initial creation and basic testing of
the representative model.
Is sometimes used as a test of the model.
Emphasizes the need for formal forecasting,
and requires close specification of the forecast
variables.
Draws managements attention to the inherent
risk in any project.
Focuses attention on accurate model building.
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Probability Distributions
of Forecast variables
Uniform: upper and lower
bounds required.