Allowing For Risk In Investment Appraisal

The purpose of investment appraisal is to assess the economic prospects of a proposed investment project. It is a methodology for calculating the expected return based on cash flow forecasts of many, often inter-related, project variables. Risk emanates from the uncertainty encompassing these projected variables. It exists because of inability of decision makers to make perfect forecasts. The evaluation of project risk therefore depends, on the one hand, on the ability to identify and understand the nature of uncertainty surrounding the key project variables and on the other hand, on having the tools and methodology to process its risk implications on the return of the project. It is accepted almost universally in the investment decision-making literature that risk and uncertainty are inherent in all investment decision-making (Groppelli and Nikbakht, 2006; Gitman, 1991; Morgan and Henrion, 1990) and hence receive considerable attention in the academic investment decision-making literature.