A Simulation Model of Capital Budgeting Under Uncertainty

This paper describes a simulation model of capital budgeting under uncertainty. It analyzes the effects of two types of uncertainty which influence the cash flows of the potential investment projects. Techniques of simulation and stochastic linear programming (using Weingartner's Basic Horizon model of capital budgeting) are employed to compute the expected return (with an associated measure of the risk involved) of different portfolios of projects. The manager can then select the portfolio which is closest to his personal risk-return preference. The model provides a practical guide to management in the entire process of project search, portfolio generation, and portfolio evaluation which characterizes the capital budgeting decision.