144 Financial Management
This probability is obtained by finding the area under the probability distribution curve
to the left or right of the specified value. Suppose the probability distribution of NPV
is as shown in Figure 6.9. If we want to calculate the probability distribution curve to
the left of 0, this is indicated by the shaded region on the left. If we are interested in
finding the probability that NPV exceeds a certain value, say Rs. 4 million, we calculate
the area under the probability distribution curve to the right of Rs. 4 million-this area
is shown as the shaded region on the right.Figure 6.9: Area Under a Normal Distribution Curve
How can we calculate the area to the left or right of a specified point? To
calculate the area to the left or right of a specified point, we use the following
procedure.
Step 1 Standardise the difference between the specified point and NPV. To do this
the difference between the specified point and NPV is divided by a(NPV).
The standardised difference may be referred to as Z. The purpose of standardisation
is to transform the actual distribution of NPV into a standard normal distribution.
The standard normal distribution has a mean of 0 and standard deviation of 1. Figure
6.10 shows the standard normal distribution.Figure 6.10: Standard Normal Distribution
Probability0 2 4 NPV (Rs. in million)-2 -1 0 +1 +2 ValueProbability