Using simulation to calculate the NPV of a project

Monte Carlo simulation is fast becoming the technology of choice for evaluating and analyzing assets, be it pure financial derivatives or investments in real assets. Two of the main virtues of simulation are flexibility and simplicity. There is no constraint on the type of uncertainty that can be modeled and most any type of decision rule can be incorporated. Simulation is also easy to implement and models can easily be constructed in spreadsheet packages. Moreover, with the surge in computing power that has taken place over the last decade, run time is no longer an issue except perhaps in the most extreme applications. Wall Street now uses Monte Carlo simulation extensively when valuing mortgage backed and other asset backed securities as well as exotic options and other derivative securities. But Monte Carlo simulation is not only useful for Wall Street, professionals analyzing real investment problems can also greatly benefit.