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Applying Simulation to Decision Problems

This article explores a simple example of using Monte Carlo simulation to analyze cash inflows and outflows, estimating probabilities, and examining the factors affecting profit. It also includes examples of quadratic utility functions and calculating net present value (NPV) for machines.

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Applying Simulation to Decision Problems

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  1. Applying Simulation to Decision Problems

  2. Monte Carlo simulation: A simple example Cash Cash inflows Probability outflows Probability ($) (%) ($) (%) 50 000   30 50 000   45 60 000   40 70 000   55 70 000   30 100 100

  3. Assigning random numbers to cash inflows Cash inflow Probability Random ($) (%) numbers 50 000 30 00–29 60 000 40 30–69 70 000 30 70–99

  4. Assigning random numbers to cash outflows Cash outflow Probability Random ($) (%) numbers 50 000 45 00–44 70 000 55 45–99

  5. Ten simulations of monthly cash flows

  6. Estimating probabilities from the simulation results

  7. The effect of the number of simulations on the reliability of the probability estimates

  8. Factors affecting profit earned by the plate

  9. Estimates of values for Elite pottery

  10. Tornado diagram for Elite pottery

  11. Probability distributions

  12. Simulation results

  13. Probability distribution of profit earned by commemorative plate

  14. Probability distribution for profit on the figurine

  15. A comparison of the two probability distributions

  16. Cumulative probability distributions

  17. First-degree stochastic dominance

  18. Two more cumulative distributions

  19. Second-degree stochastic dominance

  20. The mean-standard deviation screening method

  21. A normal distribution for profit

  22. Examples of quadratic utility functions

  23. Annual cash flows for two machines

  24. Calculating the NPV for the Alpha machine

  25. Calculating the NPV for the Beta machine

  26. Probability distributions for Alpha machine

  27. NPV probability distributions for the two machines

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