Modeling uncertainty and risk investment appraisal decisions: A Monte Carlo simulation approach

Abstract

The present paper deals with the implementation of risk analysis in engineering economic problems, using Monte Carlo simulation. The paper consists of two parts. After a short introduction about risk analysis methods used in engineering economic problems, the first part discusses the role of simulation, especially Monte Carlo simulation, in risk analysis and presents an
extended review of studies, using either statistical techniques in general, or specifically Monte Carlo simulation in risk analysis. In the second part of the paper, we construct a model of a Monte Carlo simulation for the appraisal of a potential investment with uncertain annual revenues and costs, using Excel Spreadsheets and Visual Basic. The implementation and use of the model is
demonstrated with a numerical example. The results obtained show that Monte Carlo simulation can prove a valuable technique in the decision making for the evaluation of a potential investment.

JEL Classifications: C15, Gl1, M10