Risk Analysis in Capital Investment Appraisal with Correlated Cash Flows: Simple Analytical Methods

Abstract

Since uncertainty is the crucial point of a capital investment decision, risk analysis in capital budgeting is often applied. Usually risk analysis is carried out by a Monte Carlo simulation. The aim of this article is to present simple analytical methods which allow us to calculate the standard deviation of a project with correlated cash flows as a risk measure. These methods are compared with simulation procedures carried out with R, and it is shown that the proposed simple analytical methods are indeed a quick and efficient procedure for assessing the risk of an investment project where the cash flows are correlated.