Certified Management Accountant Practice Exam

Which analysis generates a probability distribution of possible outcomes in capital investments?

1. Scenario Analysis

2. Simulation Analysis

3. Sensitivity Analysis

4. Monte Carlo Simulation

The correct answer is: Monte Carlo Simulation

The Monte Carlo Simulation stands out for its ability to generate a probability distribution of possible outcomes in capital investments. This method involves running a large number of simulations to capture the variability in key input variables, allowing for the assessment of the impact of risk and uncertainty in investment decisions. By modeling various scenarios and utilizing random variables, Monte Carlo Simulations provide a comprehensive view of potential project outcomes, complete with probabilities of achieving specific financial results. This approach goes beyond what is offered by other types of analysis. Scenario Analysis might consider specific, predetermined scenarios but does not inherently produce a probability distribution; it typically focuses on best-case, worst-case, and most likely cases. Simulation Analysis can refer broadly to generating outcomes based on various modeling techniques, but it is often more random in its nature without the extensive quantitative backing of a Monte Carlo approach. Sensitivity Analysis is valuable for understanding how changes in individual variables affect outcomes, but it does not provide a distribution of probabilities, rather it focuses on the impact of those changes. Overall, the Monte Carlo Simulation enables decision-makers to visualize a spectrum of outcomes and understand the risks associated with capital investments more clearly, making it the appropriate choice for generating a probability distribution.