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    Monte Carlo Simulation and Picking the Best Investment

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    What is a Monte Carlo simulation..? And, why is it important?

    Assume a $4,000 investment and the following cash flows for two alternatives.
    Year Investment X Investment Y
    1 $1,000 $1,300
    2 800 2,800
    3 700 100
    4 1,900
    5 2,000

    a. Under the payback method, which investment should be chosen? (Show your work/analysis/calculations for each investment).
    b. Why do other methods allow for a better analysis?

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    Solution Preview

    Dear student,

    What is Monte Carlo simulation? Why it is important?
    The Monte Carlo simulation is the fictitious representation of reality. The Monte Carlo simulation technique is used for solving mathematical or statistical problem. In the Monte Carlo simulation technique repeated sampling is used to find out the properties of some phenomenon. Monte Carlo methods are especially useful for simulating phenomena which are uncertain in inputs and systems with a large number of degrees of freedom.
    Monte Carlo simulation is important in finance area as it is useful in maximization and ...

    Solution Summary

    This solution explains what a Monte Carlo simulation is and explains the reason for its importance. Additionally, this solution explains how to determine which of two investments should be chosen.