"quantity"exercise:Common Probability Distributions

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Questions 1:

Monte Carlo simulation is best described as:

A 、providing a distribution of possible solutions to complex functions.

B 、a restrictive form of scenario analysis.

C 、an approach to back-test data.

Questions 2:

A project offers the following incremental after-tax cash flows (CF):

The internal rate of return (IRR) of the project is closest to:

quantity exercise:Common Probability Distributions

A 5.5%.

B 2.5%.

C 4.4%

View answer resolution

【Answer to question 1】A

【analysis】

A is correct. Monte Carlo simulation provides a distribution of possible solutions to complex functions. The central tendency and the variance of the distribution of solutions give important clues to decision makers regarding expected results and risk. B is incorrect; scenario analysis shows the changes in key financial quantities that result from given economic events. C is incorrect; it more correctly describes historical simulation.

【Answer to question 2】A

【analysis】

A is correct. Using a financial calculator: CF0 = –12,500, CF1 = 2,000, CF2 = 4,000, CF3 = 5,000, CF4 = 2,000, CF5 = 1,000, CF6 = 500, and solving for IRR: IRR = 5.46867% ~ 5.5%. Alternatively, the net present value (NPV) of the given cash flows can be found by using the three possible answers.

quantity exercise:Common Probability Distributions