Capital budgeting with Monte Carlo Simulation

As we mentioned at the beginning of this chapter, we can use Monte Carlo Simulation to capital budgeting when the number of variables has many different values. Our objective is to estimate the NPV for a given budget by discounting all of its future free cash flow:

Here, NPV is the Net Present Value of one proposal, FCF0 will be the free cash flow at time zero, FCFt will be free cash flow at the end of year I, R is the discount rate. The formula to calculate free cash flows at the end of year t is given here:

Here, FCTt is Free Cash Flow at year t, Dt is depreciation of year t, CaptExt is the net capital expenditure at year t, NWC is for Net working capital, which is the current asset minus current liability, Δ means change. Let's look at a simple one. Assume that the company buys one price of long term equivalent with a total cost of 0.5 million with a life of five years:

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