# Monte-Carlo Simulation and Capital Budgeting

In this section, we provide an example of how Monte-Carlo Simulation can be used for Capital Budgeting.

## Example

The Yum Yum corporation is considering the problem of marketing a new chocolate.

The investment required in the project is Rs. 2,00,000. There are two factors that are uncertain - annual demand & profit. The management has the past data regarding the possible levels of two factors.

Annual Demand Probability Profit Probability
1000 0.10 3.00 0.10
2000 0.20 5.00 0.20
3000 0.40 7.00 0.40
4000 0.20 9.00 0.20
5000 0.10 10.00 0.10

Using Monte-Carlo Simulation, determine the following:

• return on investment
• average profit
• average demand

Solution.

Table

On small screens, scroll horizontally to view full calculation

S.No. Random No. Simulated Demand (SD) Random No. Simulated Profit (SP) Return (%)
(SD X SP X 100) / 200000
1 35 3000 15 5 7.5
2 55 3000 80 9 13.5
3 10 2000 50 7 7.0
4 30 3000 90 10 15
5 70 4000 30 7 14
6 90 5000 60 7 17.5
7 25 2000 25 5 5
8 52 3000 62 7 10.5
9 62 3000 10 5 7.5
10 31 3000 2 3 4.5
Total   31000   65

Average profit = 65/10 = 6.5.
Average demand = 31000/10 = 3100.

Share and Recommend