Net Present Value from Complex Cash Flow Streams by Simulation

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Abstract
In models previously developed for the purpose of obtaining net present value from a stream of discounted cash flow increments, it is difficult to introduce complex economic, market and behavioral considerations without rendering the problem intractable computationally. Monte Carlo simulation with a digital computer, particularly in a simulation language, offers an attractive and feasible solution to the flexibility problem. This article illustrates the use of simulation techniques to find the net present value of a proposed project, together with its statistical distribution, when three types of phenomena are incorporated in the model: (1) long-term exponential market growth, (2) “non-instantaneous” response by the firm to price/elasticity fluctuations, and (3) imposition of arbitrary, yet reasonable, constraints on product output.