*This paper was prepared for the purpose of presenting the methodology and uses of the Monte Carlo simulation technique as applied in the evaluation of investment projects to analyse and assess risk. The first part of the paper highlights the importance of risk analysis in investment appraisal. The second part presents the various stages in the application of the risk analysis process. The third part examines the interpretation of the results generated by a risk analysis application including investment decision criteria and various measures of risk based on the expected value concept. The final part draws some conclusions regarding the usefulness and limitations of risk analysis in investment appraisal.
*This paper was prepared for the purpose of presenting the methodology and uses of the Monte Carlo simulation technique as applied in the evaluation of investment projects to analyse and assess risk. The first part of the paper highlights the importance of risk analysis in investment appraisal. The second part presents the various stages in the application of the risk analysis process. The third part examines the interpretation of the results generated by a risk analysis application including investment decision criteria and various measures of risk based on the expected value concept. The final part draws some conclusions regarding the usefulness and limitations of risk analysis in investment appraisal.
The paper highlights the need for a methodological framework on which to base projections in project appraisal applications. Following an initial definition and sizing of the relevant market of the project, the market is analysed in terms of which are the main customer groups, what their needs are, and how well existing suppliers serve these needs. The process should identify market performance gaps against which the project can position itself and develop relevant market competencies so that it can be assessed to be capable of out-performing competitors in meeting market expectations in a sustainable manner. This should be the essence of any project appraisal. The analyst should seek to find those elements of competitiveness that are likely to make the project a successful enterprise in its market. The quantification part of this exercise should lead to the modelling and compilation of the cash flow projections. The projected numbers should be a reflection of the competitive analysis.
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