Valuation of projects with stochastic cash flows and intertemporal correlations: Practical modeling guidelines

This paper explores the influence of cash-flow correlations on the behavior of the net present value (NPV) and internal rate of return (IRR) when performing valuations. In general, correlation has a negligible effect on the expected value of both the NPV and IRR. Even in cases of high correlation the IRR distribution departs very little from normality. In cases of moderate to low correlation, very good approximations of the SD of the NPV and IRR can be obtained, assuming that the cash flows are independent. These results, coupled with the simple two-parameter correlation structure investigated, provide a useful framework to perform valuation analysis of large-scale civil engineering projects.