Find the best-case and worst-case NPVs. What is the probability of occurrence of the worst case if the cash flows are perfectly dependent (perfectly positively correlated) over time?

By calculating the cash flows expected for a project, you can calculate both the worst and best case net present values. By multiplying the cash flows by their associated probabilities and adding them all up, you can find out what is expected of the NPV. This will give an idea as to whether or not a particular investment should be approved.

The best and worst scenarios are the ones with the highest NPVs. For example, if three outcomes were possible, the most likely outcome was the one to be considered best while the least likely outcome would have been the worst. In cases where cash flows are perfectly dependent (perfectly positively correlated) over time, then it is likely that the probability of occurrence for any one scenario would equal 100% – in other words if one event occurs then all other events must also occur.

If, for example, there are two scenarios with equal chances of happening (50%), yet their cash flow is completely dependent upon each other then this could indicate that one of them actually occurs with 100% probability. When calculating expected NPVs, it is crucial to take into account all factors to get accurate results that can inform good decision-making.