Capital budgeting

About: Capital budgeting is a research topic. Over the lifetime, 4644 publications have been published within this topic receiving 132948 citations. The topic is also known as: investment appraisal.

The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets

Abstract: Publisher Summary This chapter discusses the problem of selecting optimal security portfolios by risk-averse investors who have the alternative of investing in risk-free securities with a positive return or borrowing at the same rate of interest and who can sell short if they wish. It presents alternative and more transparent proofs under these more general market conditions for Tobin's important separation theorem that “ … the proportionate composition of the non-cash assets is independent of their aggregate share of the investment balance … and for risk avertere in purely competitive markets when utility functions are quadratic or rates of return are multivariate normal. The chapter focuses on the set of risk assets held in risk averters' portfolios. It discusses various significant equilibrium properties within the risk asset portfolio. The chapter considers a few implications of the results for the normative aspects of the capital budgeting decisions of a company whose stock is traded in the market. It explores the complications introduced by institutional limits on amounts that either individuals or corporations may borrow at given rates, by rising costs of borrowed funds, and certain other real world complications.

Real Options: Managerial Flexibility and Strategy in Resource Allocation

Abstract: In the 1970s and the 1980s, developments in the valuation of capital-investment opportunities based on options pricing revolutionized capital budgeting. Managerial flexibility to adapt and revise future decisions in order to capitalize on favorable future opportunities or to limit losses has proven vital to long-term corporate success in an uncertain and changing marketplace.In this book Lenos Trigeorgis, who has helped shape the field of real options, brings together a wealth of previously scattered knowledge and research on the new flexibility in corporate resource allocation and in the evaluation of investment alternatives brought about by the shift from static cash-flow approaches to the more dynamic paradigm of real options -- an approach that incorporates decisions on whether to defer, expand, contract, abandon, switch use, or otherwise alter a capital investment.Comprehensive in scope, Real Options reviews current techniques of capital budgeting and details an approach (based on the pricing of options) that provides a means of quantifying the elusive elements of managerial flexibility in the face of unexpected changes in the market. Also discussed are the strategic value of new technology, project interdependence, and competitive interaction.The ability to value real options has so dramatically altered the way in which corporate resources are allocated that future textbooks on capital budgeting will bear little resemblance to those of even the recent past. Real Options is a pioneer in this area, coupling a coherent picture of how option theory is used with practical insights in into real-world applications.

Evaluating Natural Resource Investments

Abstract: Notwithstanding impressive advances in the theory of finance over the past 2 decades, practical procedures for capital budgeting have evolved only slowly. The standard technique, which has remained unchanged in essentials since it was originally proposed (see Dean 1951; Bierman and Smidt 1960), derives from a simple adaptation of the Fisher (1907) model of valuation under certainty: under this technique, expected cash flows from an investment project are discounted at a rate deemed appropriate to their risk, and the resulting present value is compared with the cost of the project. This standard textbook technique reflects modern theoretical developments only insofar as estimates of the discount rate may be obtained from crude application of single period asset pricing theory (but see Brennan 1973; Bogue and Roll 1974; Turnbull 1977; Constantinides 1978). The inadequacy of this approach to capital budgeting is widely acknowledged, although not widely discussed. Its obvious deficiency is its The evaluation of mining and other natural resource projects is made particularly difficult by the high degree of uncertainty attaching to output prices. It is shown that the techniques of continuous time arbitrage and stochastic control theory may be used not only to value such projects but also to determine the optimal policies for developing, managing, and abandoning them. The approach may be adapted to a wide variety of contexts outside the natural resource sector where uncertainty about future project revenues is a paramount concern.

A state-preference model of optimal financial leverage

Abstract: IN COMPLETE and perfect capital markets, Hirshleifer [6, 7], Robichek and Myers [13], and Stiglitz [15] have shown that the firm's market value is independent of its capital structure. Although firms may issue conventional types of complex securities, such as common stocks and bonds, if the number of distinct complex securities equals the number of states of nature, individuals are able to create primitive securities. A primitive security represents a dollar claim contingent on the occurrence of a specific state of nature and can be created by purchasing and selling short given amounts of complex securities. Since in a perfect market the firm is a price taker, the market prices of these primitive securities are unaffected by the firm's financing mix. Therefore, given the firm's capital budgeting decisions which determine the firm's returns in each state, the firm's market value is independent of its capital structure. The market value of the firm equals the summation over states of the product of the dollar return contingent on a state and the market price of the primitive security representing a dollar claim contingent on the occurrence of that state. The proof of the Modigliani-Miller [8] independence thesis in a statepreference framework does not depend upon the assumption that the firm will earn its debt obligation with certainty. The firm may not earn the "promised" return on its bonds in some states of the world and would be bankrupt. In these states the firm's bonds are claims on the residual value of the firm. Although the firm's financing mix determines the states in which the firm is insolvent, the value of the firm is not affected since bankruptcy penalties would not exist in a perfect market. Therefore, sufficient conditions for the Modigliani-Miller independence thesis are complete and perfect capital markets. The taxation of corporate profits and the existence of bankruptcy penalties are market imperfections that are central to a positive theory of the effect of capital structure on valuation. A tax advantage to debt financing arises since interest charges are tax deductible. Assuming that the firm earns its debt obligation, financial leverage decreases the firm's corporate income tax liability and increases its after-tax operating earnings. However, a corporate bond is not merely a bundle of contingent claims but is a legal obligation to pay a fixed