Professional Documents
Culture Documents
Random Variables
› Using random variables we can work out expected values and variances
“In reality, killing time is only the name for another
- Particularly helpful in decision making by making the uncertainty associated with
of the multifarious ways by which time kills us.” each alternative more explicit
~Osbert Sitwell
1
13/05/2011
› Capital letters such as X, Y and Z are used to represent random variables › A random variable X is discrete if it can take on (at most) a finite number of
values (x1,x2…xL)
› Lower-case letters (x, y, z) denote the particular values that these
variables take on in the sample space (i.e., the set of all possible › The probability that a discrete random variable X takes on the value xi is
outcomes for each variable) given by
Pr{X = xi} = p(xi) for i = 1,2,….,L (i is a sequential index of the discrete values, xi,
that the variable takes on)
› When random variable X follows some discrete probability distribution, its where p(xi) > 0 and p(xi) = 1
i
probability mass function is usually indicated by p(x) and its cumulative
distribution function by P(x)
› When random variable X follows a continuous probability distribution, its
probability density function is usually indicated by f(x) and its cumulative
distribution function by F(x)
7 8
› A random variable X is continuous, if a non-negative function f(x) exists, › The expected value of a single random variable X, E(X), is a weighted
such that for any real numbers [c,d], the probability of the event occurring average of the distributed values x that it takes on and is a measure of the
is (i.e. the probability that X is within the set of real numbers [c,d] ): central location of the distribution
d
› Pr{c ≤ X ≤ d} = c f(x) dx › E(X) is the first moment of the random variable about the origin and is
› And f(x)dx = 1 called the mean of the distribution
The probability that the value X is less than or equal to k, i.e. the cumulative E(X) = xi p(xi ) for x discrete and i = 1,2,…,L
i
distribution function F(x) for a continuous case is:
k
Pr{X < k} = F(k) = f(x) dx
E(X) = x f(x) dx
for x continuous
9 10
› For a single random variable, the variance is a measure of dispersion of › When a random variable, X, is multiplied by a constant, c, the expected
the values it takes on around the mean value E(cX), and the variance, V(cX) are:
› V(X) = E(X2) – [E(X)]2 › E(cX) = cE(X) = cxi p(xi) for discrete
i
› V(X) = x2p(xi) – [E(X)]2 for x discrete › E(cX) = cE(X) = cx f(x) dx for continuous
i
› V(X) = xi2(x) dx – [E(X)]2
for x continuous › V(cX) = c2V(X)
11 12
2
13/05/2011
Multiplication of Two Independent Random Variables Multiplication of Two Independent Random Variables
› When a random variable, Z, is a product of two independent random • Thus if Z is the random variable then,
variables, X and Y, the expected value, E(Z), and the variance, V(Z) are
› Z= XY
› V(Z) = { V(X) + [E(X)]2 } { V(Y) + [E(Y)]2 } – [E(X)]2 [E(Y)]2
› E(Z) = E(X) E(Y)
› V(Z) =E(X2)E(Y2)– [E(X) E(Y)]2 Or
13 14
› Average property damage is $20,000, when storm flow is greater than the
capacity. Reconstruction of the channel will be financed by 40-year bonds
bearing 8% interest per yr. Determine the most economical channel size.
15 16
17 18
3
13/05/2011
(1) EOY Net Cash Flow (2) (3) (4) = (2) x (3) (5) = (2)2 (6) = (3) x (5)
› (a) E(PW) = (PW j )p(j) = $39.56
j
21 22
› Two frequently used assumptions are: › Assume that the annual net cash-flow amounts for this project are
1) Uncertain cash-flow amounts are distributed according to the normal normally distributed with the expected values and standard deviations as
distribution given below and are statistically independent. MARR = 15% per year. Find
the E(PW), V(PW) and SD(PW).
2) Uncertain cash flow amounts are statistically independent (i.e. no
correlation between cash flow amounts is assumed)
EOY, k Expected Value of NCF, E(Fk) SD of NCF, SD(Fk)
Thus if we have a linear combination of two or more independent cash
flow amounts (e.g. EW = c0F0 + … +cNFN) 0 -$7,000 $0
…Then using the expressions gained from multiplication of a random 1 $3,500 $600
variable by a constant, we obtain: 2 $3,000 $500
N
V(PW) = C V F
k 0
2
k k
3 $2,800 $400
And, E(PW) = C E F
k 0
k k
23 24
4
13/05/2011
› V(PW) = C V F
k 0
2
k k
› Based on Example 12-6, find out Pr{IRR < MARR}. Assume that the PW of
the project is a normally distributed random variable.
› From Appendix E in the textbook pg. 648 (Normal Distribution Tables):
( X )
Z
› Recall that when IRR < MARR, the PW < 0
PW E ( PW ) 0 153
› Thus, Z 0.22
SD( PW ) 696
› Cash flows for a project are shown in the table below with a 5-year study EOY, k Fk E(Fk) = akE(Xk) + bkE(Yk) V(Fk) = ak2V(Xk) + bk2V(Yk)
period. The net cash flow of the project is a linear function of both Xk and 0 F0 $0 - $100,000 = -$100,000 0+(1)2(10,000)2 = 100x106$2
Yk, where both are continuous random variables and are independent of 1 F1 60,000 – 20,000 = 40,000 (4,500)2+(1)2(2,000)2 = 24.25x106
each other. MARR=20%. Find E(PW), V(PW) and SD(PW). What is the
2 F2 65,000 – 2(15,000) = 35,000 (8,000)2+(2)2(1,200)2 = 69.76x106
probability that PW < 0?
3 F3 2(40,000) – 3(9,000) = 53,000 (2)2(3,000)2+(3)2(1,000)2 = 45x106
EOY, k NCF Expected Value SD
4 F4 70,000 – 2(20,000) = 30,000 (4,000)2+(2)2(2,000)2 = 32x106
Fk = akXk - bkYk Xk Yk Xk Yk
5 F5 2(55,000) – 2(18,000) = 74,000 (2)2(4,000)2+(2)2(2,300)2 = 85x106
0 F0 = X0+Y0 $0 -$100,000 $0 $10,000 5
N
5
13/05/2011
Example 12-8
End of Sharing
N
› V(PW) = Ck V Fk = V(Fk)(P/F, 20%, k)2
2
k 0 k 0
› = 100 x 106 + (24.25 x 106)(P/F, 20%, 1)2 + ... + (85 x 106)(P/F, 20%, 5)2
› = 186.75 x 106 $2
Thank You
› SD(PW) = [V(PW)]1/2 = $13,666
› Pr{PW < 0}? Assume net cash flow is normally distributed, thus:
PW E ( PW ) 0 $32,517
Z 2.3794
SD( PW ) $13,666
› Hence, Pr{PW ≤ 0} = Pr{Z ≤ -2.3794} = 0.0087
31