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Monte Carlo Simulation
Monte Carlo Simulation
Probability Fundamentals
• Event
A desired outcome
• Probability
The chance of getting a desired outcome
Probability Example
Joe is tossing a die. What is the probability of getting the
two dots on the top side, once the die lands on the table?
Event
Getting the two dots on the top side
Probability
Discrete Probability Distribution
An analyst is predicting the stock price of GoProLogistics. He estimates
that the probability of reaching $92 per share is 10%, the probability of
reaching $93 per share is 30%, the probability of reaching $94 per
share is 20%, and the probability of reaching $95 per share is 40%.
Probability
45%
40%
35%
30%
25% Probability
20%
15%
10%
5%
0%
$92 $93 $94 $95
Probability for Continuous Data
An analyst is predicting the stock price of GoProLogistics.
He estimates the stock can reach any price between $80
and $100 per share. For example, the price can be $80 per
share, or $92.18 per share, or $99.56 per share, etc.
• Selling price per unit (p). The price for the new phone is
$249 each.
• First-year administrative and advertising costs (ca).
Currently, this cost is $1,000,000.
• direct labor cost per unit (ci).
• parts cost per unit (cp).
• first-year demand (d).
Current Analyses
• Base-Case Scenario
• Best-Case Scenario
• Worst-Case Scenario
Base-Case Scenario
• The base-case estimates of the direct labor cost per unit,
the parts cost per unit, and first-year demand are $45,
$90, and 15,000 units, respectively. Using these
estimations, the profit projection is:
Direct Probability
Labor
Cost
$43 0.1
$44 0.2
$45 0.4
$46 0.2
$47 0.1
Part Cost Per Unit
Demand
1000 Scenarios
• In the first scenario, we let the analysis software generate
a random number Δ for direct labor cost per unit, part cost
per unit, and demand.
• Corresponding to each random number Δ, we can find the
direct labor cost per unit, part cost per unit, and demand
that are most likely to occur.
• Use the predicted direct labor cost per unit, part cost per
unit, and demand to calculate the profit in the first
scenario.
• Repeat the steps above to get the other 999 scenarios.
• Predict the probability distribution of profit.
Example
In the first trial, the analysis software generate the following random
numbers for the three factors.
Factor Random Number
Direct Labor Cost per Unit 0.4
Part Cost per Unit 0.3
Demand 0.6
Corresponding to these random numbers, the following events are
most likely to occur.
Factor Predicted Value
Direct Labor Cost per Unit $45 (Because $45 is most likely to occur at
the probability of 0.4 according to the direct
lab cost’s probability distribution)
Part Cost per Unit $86 ($80+0.3*(100-80)=$86)
Demand 16141 (Use =NORM.INV(0.6,15000,4500)
function)
Thus, the estimated profit in the first trial is
Profit = (249 - 45 - 86) * 16,141 – 1,000,000 = 904,638
Random Value in Uniform Probability