Monte Carlo Simulations and Sceenrio Analyst —

Abstract

Monte Carlo simulation refers to a computer spreadsheet model that can generate answers to "what if" scenarios involving multiple variables (i.e., a manager's possible decisions). The possible outcomes of a decision are recalculated repeatedly, each time using different randomly selected values of "inputs," where the inputs represent the managers' options. Using a hypothetical case study, this article shows how Monte Carlo simulations are applied in four steps. First, define the problem and build the exact relationship between the input and output variables into a computer spreadsheet. Second, identify input variables that are uncertain but crucial and model them as probability distributions. Third, have the computer generate a wide range of possible outcomes, their probabilities, and related trends. Fourth, based on the simulation results and outcome probabilities obtained in the third step, choose the preferred course of action.