I ran simulation of DCF cashflows with uncertainty in inputs. For this, I have taken basic RISK Model as a reference.

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Uncertain Inputs

In this model, the following inputs are uncertain:

1. Investment cost

2. Year 1 revenue

3. Annual fixed cost

4. Annual revenue growth rate

5. Annual variable cost percentage

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Meaning of uncertainty in this context

For example, you may estimate average growth rate to be 5% but in reality there will always be certain variation right? it may have a standard deviation of up to +/- 2% (example) based on historical forecast errors. Here you might go for a normal distribution.

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The decision of what distribution to consider for what parameter depends on the context.

Similarly, you may estimate the 1st year revenue to be within a particular range say Rs. 75k to Rs. 125k but somewhat near to Rs. 1.15 Lakh. Here you may go for Triangle Distribution.

Whenever there is uncertainty, we need to choose a suitable distribution for each input and then run a simulation "n" number of times to know the final range of output within certain level of confidence.

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Simulation Details

1. Number of Iterations 5,000

2. Cashflows: 10 Years

3. Fixed Discount Rate of 12%

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Tools/Techniques

RISK Tool by Palisade (Academic Version) on MS Excel.