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Acb III Dependence of Cashflows
Acb III Dependence of Cashflows
Acb III Dependence of Cashflows
OVER TIME
DEPENDENCE OF CASHFLOWSINTRODUCTION
Independence of cash flows are less risky
than dependent cash flows. In many projects, the cash flow in one future period depends in part on the cash flows in previous periods. Therefore, it is realistic to assume that in case of investment projects that cash flows are dependent overtime.
DEPENDENCE OF CASHFLOWS
The favorable or unfavorable outcome in
earlier periods is generally accompanied by the favorable or unfavorable outcome in the later periods in the life of an investment project.
DEPENDENCE OF CASHFLOWS
When cash flows are dependent overtime,
the S.D. will be larger than what would be under the assumption of independence of cash flows. The greater will be the degree of correlation between cash flows, the larger will be the S.D.
DEPENDENCE OF CASHFLOWS
However, the expected value of NPV remains
PERFECT CORRELATION
Cash flows are perfectly correlated overtime if
PERFECT CORRELATION
The formula for the S.D. of the cash flows in
MODERATE CORRELATION
In certain cases, the cash flows are neither
independent nor perfectly correlated overtime. They are rather moderately correlated. One method of dealing with the problem of moderate correlation is with the series of conditional probability distribution and decision trees.
MODERATE CORRELATION
The use of conditional probability distributions
enable us to take account of the correlation of cash flows overtime. Formula for determining S.D. is =(NPVj ENPV)2 p
SIMULATION
For complex situations, the mathematical
calculation of S.D. is unfeasible. For these situations, we can approximate the S.D. by means of simulation. With this method, we use random sampling to select cash flow series for evaluation and calculation of NPV or IRR for each selected series.