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Cost of capital and capital investment decisions

Introduction

1.1 Risk and investment appraisal

When looking at investment appraisal we are particularly concerned with
changes in business risk (what the project activity involves) and gearing
risk (how it will be financed).

Key questions:

 how to measure and evaluate the different risks involved

 how each method incorporates risks into the decision making process

 how to decide on which investment appraisal technique to use, based on the
risks

 how to implement the techniques specified.

1.2 Incorporating risk

All investment appraisals are based on estimates of likely project returns.

Uncertainty in the estimates can be dealt with using:

 sensitivity analysis

probabilities/expected values

 certainty equivalents

 risk-adjusted discount rates.

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