Analysis of Risk and Uncertainty Using Monte Carlo Simulation and its Influence on Project Realization

Goran Karanovic () and Bisera Gjosevska ()
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Goran Karanovic: University of Rijeka, Faculty of Tourism and Hospitality Management, Croatia
Bisera Gjosevska: Balkan Institute for Behavioral Research, Skopje, Macedonia

Annals - Economic and Administrative Series -, 2012, vol. 6, issue 1, 145-162

Abstract: This paper examines the impact of risk and uncertainty on the the capital budgeting process in the modern business environment. The turbulent business surroundings, as well as the rapid technological, informational, and societal progress and scientific development add to the complexity of modern-day decision making, by exerting significant influence on the growing uncertainty during the capital budgeting process. A summary of the most common sources of risk and uncertainty in the capital budgeting process is given, as well as an overview of the most represented methods for the evaluation of financial efficiency in the capital budgeting procedure. The determination and quantification of risk and uncertainty regarding key variables is of paramount importance to the analysis in question, as is their influence on the distribution of the resulting values of the methods of evaluating capital budgeting. Exceptional attention in this paper has been given to the comparison and contrast of distribution of values procured from the use of the methods for the determination and quantification of risk and uncertainty. In the following case study — the decision regarding the construction of a hotel — the use of the Monte Carlo simulation method has been shown in the process of determining the probability distribution of net present value, as well as the forecasting of cash flows. The given example shows, through analysis and observation, the most important issues and advantages arising from the use of the Monte Carlo method as well as the shortcomings in the use of this model in business practice.

Keywords: risk; uncertaint; Monte Carlo simulation; capital budgeting (search for similar items in EconPapers)
Date: 2012
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