Capital Expenditure

Decisions Under Risk

and Uncertainty
 What is Capital Expenditure Decisions?
Capital Expenditure is the technique of making
decisions for investment in long-term proposals. It is a
process of deciding whether or not to invest the funds
in a particular proposal, the benefit of which will be
available over a period of time longer than one year.
"Capital Budgeting involves the
planning of expenditures for assets, the returns from
which will be realized in future time periods."
 Funds are invested in long-
term assets.
Funds are invested in present
Features times in anticipation of
of Capital future profits.
Budgeting The future profits will occur to
Decisions: the firm over a series of years.
Capital Budgeting decisions
involve a high degree of risk
become future benefits are
not certain
 Types of Capital Investments

Types of Capital
Investments

Physical Monetary Intangible

Assets Assets Assets
 Monetary Assets
a) Deposits
b) Bonds
Physical Assets
c) And Equity Shares
a) Land
b) Building Intangible Assets
c) Plant a) Research and development
d) Machinery b) Training
e) Vehicles
c) Market development
f) And Computers
d) franchises
 Planning

Phases Analysis

or
Selection
Process
of Financing

Capital
Expenditure​ Implementation

Review
 • Such Decision affect
the profitability of the Firm
• Irreversible Decision
• Involvement of Large Amount
Importance of ​C of Funds
apital ​Expenditu • Risk
re ​Decision​
• Most difficult to make
• Long Term Effects
 • Actions
• Different levels of demand
• Probabilities of the states
• Outcomes
• Utility
• Decision under certainty
Elements • Decision under
of ​Decisio uncertainty
n Making ​ • Decision under risk
 Technical Risk
Economic Risk
Political Risk
Business Risk
Financial Risk
Cyclical Risk
Purchasing Power Risk
Interest Rate Risk

Types an Stock Price Risk

Tax Law Risk
d Sources Foreign Exchange Risk
Risk due to nature of type of
of Risk​ financing
Risk of misinterpretation
Behavior of decision Maker
  Probability and expected values​
 Optimistic- Most likely- Pessimistic
TECHNIQUES estimates
FOR DECISION-  Value of information
MAKING UNDER  Sensitivity analysis
RISK AND  Simulation​
UNCERTAINTY  Standard deviation​
 Certainty equivalent approach
 Risk Adjusted Discount Kate or Capital As
set Pricing Method (CAPM)​
 Project Beta
 Decision trees