Probability analysis, Financial Accounting

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Probability Analysis

This engrosses the assessment of the probabilities of future events linked to an investment project. If these events are universal circumstances the technique is called scenario analysis. For instance an assessment might be made of the outcome of an investment project under poor and moderate and good economic conditions and the probability of each economic state arising assessed.

Another approach is to assess the likelihood of particular values of project variables occurring therefore that a probability distribution for each variable can be determined. This cause the technique called simulation or the Monte Carlo method which results in a probability distribution for the project NPV.

With both approaches it is consequently possible to determine the expected net present value (ENPV) based on all possible outcomes, and the probability of a negative or zero NPV. The problem with possibility analysis is that in practice it is difficult to determine the probabilities to be attached to future events. An inescapable element of subjectivity is probable to exist in probability estimates.


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