Abstract

The crucial importance of capital investment decisions has been stressed in practically all of the literature on this popular topic that has appeared in recent years. Whatever differences students of this subject may have, they generally agree that making good capital investment decisions is vital to the success of the firm and fraught with risk. Despite widespread concern over the inherently risky nature of the capital investment process, however, there have been relatively few attempts to deal with such risk in an explicit, quantitative fashion. A notable exception is author David B. Hertz's "Risk Analysis in Capital Investment," which advocates the use of an electronic computer to simulate the proposed investment. Variable estimates of input data are used and the resulting dispersion of computed rates of return enables the decision maker to gauge the project's risk. The simulation approach is very flexible and hence it is well suited to appraising large, complex investment proposals. However, it is not a simple or inexpensive method of dealing with risk and, fortunately, it is not the only method. There is a relatively easily applied analytical approach which can be used wherever its assumptions apply; indeed computer simulation need be resorted to only when a project's character is such that these assumptions are violated.