Uncertainty and Capital Budgeting.

Abstract The article presents an approach to capital budgeting that involves formal recognition of the fact that future cash flows are not known with certainty. The uncertainty is incorporated in the analysis by the utilization of probability theory. The approach referred to as the probability approach to capital budgeting. For purposes of describing the probability approach to capital budgeting the net present value of an investment will be used as a measure of the worth of the investment. If an investor wishes to use the rate-of-return approach instead of the net present value approach, the essentials of the probability approach to capital budgeting would be the same. In order to understand the probability approach to capital budgeting, one must be familiar with certain concepts from probability theory. A probability beliefs approach has been suggested in connection with the portfolio selection problem and could be adapted to the capital budgeting problem. Another approach might be suitable in certain cases that would involve the use of historical data.