Uncertainty and capital budgeting acct 7320 12 4 13 bailey
Download
1 / 11

Uncertainty and Capital Budgeting ACCT 7320 , 12/4/13, Bailey - PowerPoint PPT Presentation


  • 95 Views
  • Uploaded on

Uncertainty and Capital Budgeting ACCT 7320 , 12/4/13, Bailey. This presentation contains two parts: A general model of decision-making under uncertainty, using “expected value”

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about ' Uncertainty and Capital Budgeting ACCT 7320 , 12/4/13, Bailey' - frey


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
Uncertainty and capital budgeting acct 7320 12 4 13 bailey
Uncertainty and Capital BudgetingACCT 7320, 12/4/13, Bailey

  • This presentation contains two parts:

    • A general model of decision-making under uncertainty, using “expected value”

    • Discussion of “Using Decision Trees to Manage Capital Budgeting Risk,” J. Bailes & J. Nielsen, Management Accounting Quarterly, Winter 2001


Decision models and uncertainty
Decision Models and Uncertainty

  • Managers frequently must deal with uncertainty.

  • The model presented here represents a rational approach to decision making under uncertainty, assuming you are risk-neutral.


Decision model assumptions
Decision Model Assumptions

  • Choice Criterion

  • Set of Alternatives (Actions to consider)

    Mutually exclusive, Exhaustive

  • Set of Events (States of Nature)

  • Set of Probabilities associated with the events

  • Set of Outcomes (Income, cost, etc., to minimize or maximize)


Example of dm under uncertainty
Example of DM under Uncertainty

Action Taken

Buy new Eqpt Keep old Eqpt

E Get Govt Income = Income =

v Contract $500,000 $300,000

e

n Not get Govt Income = Income =

t Contract $10,000 $200,000

  • Which action is best?

    Depends on probabilities we assign to the events.


Decision models and uncertainty1
Decision Models and Uncertainty

  • EV=Σ(Outcomei) (Pi)

    i.e., summation of each outcome (in this case, income)

    times the probability of that outcome.

  • Suppose P(getting contract) = .20

    [read as “probability of getting contract = .20”]

  • Thus P(not getting contract) = .80.

  • EV(buying new Eqpt) = $500,000*.20 + $10,000*.80 = $108,000

    EV(keeping old Eqpt) = $300,000*.20 + $200,000*.80 = $220,000

  • To maximize expected value, we keep old equipment.


Forest product companies and timberland
Forest Product Companies and Timberland

  • Long-term capital-budgeting decisions

    • More risk

    • Time value of money especially important

  • Typical decision:

    • Buy timberland now, or

    • Buy timber as needed


The basic decision
The basic decision

Starting point in hypothetical case assumes indifference given the current regulatory environment, for simplicity only.



Uncertainty regulatory environment may change
Uncertainty: Regulatory environment may change

Difference in these two columns is NPVof buying now

Difference in these two columns is NPVof buying as needed.




ad