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”
Mutually exclusive, Exhaustive
Buy new Eqpt Keep old Eqpt
E Get Govt Income = Income =
v Contract $500,000 $300,000
n Not get Govt Income = Income =
t Contract $10,000 $200,000
Depends on probabilities we assign to the events.
i.e., summation of each outcome (in this case, income)
times the probability of that outcome.
[read as “probability of getting contract = .20”]
EV(keeping old Eqpt) = $300,000*.20 + $200,000*.80 = $220,000
Starting point in hypothetical case assumes indifference given the current regulatory environment, for simplicity only.
Difference in these two columns is NPVof buying now
Difference in these two columns is NPVof buying as needed.