Essentials of Financial Management, 5th Edition by Pearson

CHAPTER 9

Risk Analysis in Capital Budgeting

LEARNING OBJECTIVES

• Discuss the concept of risk in capital budgeting decisions
• Describe commonly used techniques of handling risk
• Illustrate the use of certainty equivalent and risk-adjusted discount rate in handling a project’s risk
• Show the equivalence of certainty equivalent and risk-adjusted discount rate
• Explain the decision tree approach in sequential investment decisions

INTRODUCTION

In discussing the capital budgeting techniques, we have so far assumed that the proposed investment projects do not involve any risk. This assumption was made simply to facilitate the understanding of the capital budgeting techniques. In a real-world situation, however, the firm in general and its investment ...