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Risk Evaluation of Capital Investments: A Survey

Risk Evaluation of Capital Investments: A Survey

1974Working Paper No. 236

This is a survey of techniques for evaluation of risk in individual capital investment projects. The paper identifies the four types of relationships affecting project uncertainty; 1)Accounting-type relationships defining cash flow; 2)Statistical relationships among variables in a given time period; 3)Autocorrelation relationships among cash flows over time; and 4)Uncertainty about project life. Two types of decisions also can affect project profitability and uncertainty: 1)Strategy decisions; and 2) Abandonment decisions. Four types of models for risk evaluation are identified: 1)Certainty model; 2)Hillier model; 3)Monte Carlo model; and 4)Decision Tree model. These four types of models are compared and evaluated in terms of how easily they can incorporate the relationships and decisions mentioned above. Computational issues are also discussed. Suggestions are made for further research.