Thesis (Ph. D.)--University of Wisconsin--Madison, 1966. / Typescript. Vita. eContent provider-neutral record in process. Description based on print version record. Includes bibliographical references.

Thesis (Ph. D.)--University of Washington, 1981. / Vita. Bibliography: leaves [71]-75.

Thesis (D.P.A.)--University of Illinois at Springfield, 2006. / Vita: leaf 277. Includes bibliographical references (leaves 256-269).

A description of the events that preceeded an actual capital investment decision illustrates the importance of uncertainty in the decision process and provides a basis for developing criteria related to the needs of the decision maker in dealing with uncertainty. The sequence of events leading to the acceptance or rejection of a capital investment proposal is best characterized as a decision process in which uncertainty in the input information is reduced to a level consistent with the risk assuming preferences of the firm. The use of formal methods to relate economic benefits, uncertainty, and the risk assuming preferences of the firm within a single framework has been suggested and two methods, employing subjective probabilities as their distinguishing characteristic, are presented for analysis. The theory of subjective probability is found to gain acceptance only if specific assumptions are judged to be acceptable. A second set of assumptions also requires acceptance to justify utilization of the theory in any given practical situation. The analysis of the two methods, in relation to the criteria developed from the actual example, indicates that complete formalization cannot be attained in that no acceptable means of formally incorporating analysis of the risk assuming preferences of the firm is provided. The use of subjective probabilities serves only to formally combine economic benefits and uncertainty. Use of the resulting probability distributions must be based on an acceptance of the underlying assumptions of the theory and serve only as an aid to judgement. Any decision for the use of subjective probability distributions must rest with the individual decision maker. / Business, Sauder School of / Graduate

This study consists of a critical evaluation of the role of the cost of capital as a "risk-adjusted" discount rate in the economic analysis of capital investments. In conventional theory, the cost of capital is formulated as a discount rate which serves as a financial standard, in accordance with one variation or another of the following definition: The cost of capital is the minimum acceptable rate of return that a proposed investment in real assets must offer in order to be worthwhile undertaking from the stand-point of the current owners of the firm. Unfortunately, theorists have found it difficult to incorporate a proper measure of risk into the specification of the cost of capital as a single-valued rate of discount. Ezra Solomon, among others, has avoided much of the difficulty by assuming that all projects to be evaluated are of a quality, in respect to uncertainty of future earnings, which is "homogeneous" with the quality of earnings attributed to existing operations. The problem of dealing with investments of a quality significantly different from earnings from existing assets is largely unresolved. This study consists of an analysis of the relationship which should exist between a project's risk and the cost of capital appropriate to its evaluation. The analysis rests upon several simplifying assumptions regarding the behavior of investors and capital markets; and employs for its investigation two models of risk and valuation: The classical certainty-equivalence model and John Lintner's recently derived risk asset valuation and portfolio selection model. In recognition of certain weaknesses in the conventional discounted cash flow approaches to capital project evaluation, several theorists including David B. Hertz and Frederick S. Hillier, have proposed that Monte Carlo Simulation and analytical-statistics methods be employed to account for risk by generating stochastic expressions for valuation indices. To the extent that the expression of probabilistic valuation indices depends upon a "risk-adjusted" cost of capital discount rate, there exists the inconsistency of "double accounting for risk;" once in the cost of capital, and once again in the stochastic expression of the indices themselves. This study assesses the relevance of the cost of capital as a discount rate in the generation of stochastic discounted cash flow indices. The investigation disclosed that: (1) the cost of capital is a derived variable consisting of a complex function of the risk-free rate of interest, and the expected values and risk parameters of earnings expectations of the firm, the project concerned, and securities comprising the market as a whole; that (2) the cost of capital is essentially inefficient as a means of accounting for risk because its correct derivation depends upon the employment of a valuation model which is of itself both sufficient and more direct as a means of evaluation; and (3) that the cost of capital, as a "risk-adjusted" rate of discount is both inappropriate and irrelevant for employment in the generation of stochastic expressions of valuation indices. / Business, Sauder School of / Graduate

Although we live in a world of considerable uncertainty and chance, most capital investment decisions consider the element of risk only qualitatively, if at all. The believed risk should be an explicit and quantitative part of the normal excess present value or excess rate of return method of investment analysis. These risks are described by the subjective probability distribution of possible investment outcomes and the coefficient of variation of this distribution is a measure of the relative risk. At the same time, only incremental risk is relevant which depends upon the existing earnings risk as well as the project earnings risk and the coefficient of association between these streams. Risk bears on the investment valuation through the investor's attitude which is conditioned by his sense of economic wealth and his psychological reaction to the risk phenomenon. This felt risk can be quantified through the investor's trade-off between income and risk, or his utility of money function. This is then used to modify the uncertain expected income to an equivalent certain income which is then evaluated in the normal way. However, this is only feasible for individual investors or small groups of co-investors. For corporate investment decisions it is preferable to relate the risk to a variable rate of required return or market discount. This rate then enables the uncertain expected income to be evaluated directly In the usual manner. This method is applicable on any entity basis including the individual project which is the unit of investment decision. Here the venture has a unique risk with an appropriate capital structure and cost of capital funds. In fact, this method of evaluation depends upon the existence of a valuation function expressing the cost of corporate capital under risk. The cost of capital has been a difficult concept to define and measure while the aspect of risk has received little attention. Thus the rigorous Modigliani and Miller statement of the valuation of earnings under risk is highly significant. Here earnings risk is classified on the basis of equal coefficient of variation and perfect correlation. The use of debt capital creates financial risk but displays cost advantages under tax. However, leverage is restrained by an interest rate function which is related to financial risk and the uncertainty of creditor payments. Implicit in the formulation of this hypothesis is an investor loss aversion attitude which might be broadened into a risk aversion basis of valuation. The comprehensive hypothesis, with a point of minimum cost of capital, provides a strong theoretical position but is difficult to empirically validate. The valuation of after-tax earnings under variable risk can be inferred from the Modigliani and Miller hypothesis. From this can be derived a general expression for the marginal value of an investment under risk. This includes the special case, usually assumed, where the investment income is of equivalent risk and perfectly correlated to the existing corporate income. The method may be used to evaluate alternative financing arrangements and mutually exclusive projects as well as insurance proposals. This variable rate of discount or return concept provides a direct and intuitively appealing means of adding another dimension to the analysis of investment opportunities. Although there is need for theoretical development, empirical verification and organizational acceptance of this approach, it is perhaps a basis for improved corporate investment decisions under risk. / Business, Sauder School of / Graduate

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Wien, WirtschaftsUniversität, Thesis (doctoral).

Thesis--Geneva, 1974. / "Collection des thèses de la Faculté des sciences économiques et sociales. Thèse no 234." Includes bibliographical references (p. 211-220).