Risk and capital budgeting

Abstract

Capital budgeting in a live environment is crucially influenced by exposure to risk. Argues that while there are many risk analysis techniques that could be used to assist with investment appraisal (for example the incorporation of risk premiums in discount rates, simulation, sensitivity analysis, etc.), it is not often recognized that the most widely used method – net present value (NPV) and nearly all of its variants – will often lead to incorrect conclusions when exposure to risk is not correctly incorporated. When risk is properly accounted for, surprising results emerge in evaluating project viability and sensitivity with respect to risk.