Correct Procedures for the Evaluation of Risky Cash Outflows

Laurence D. Booth

Journal of Financial and Quantitative Analysis, 1982, vol. 17, issue 2, 287-300

Abstract: The purpose of this paper is to determine the correct procedure for discounting cash outflows in a capital market context. Beedles has stated flatly that “the risk adjusted discount (RADR) approach should not be applied to investment projects with negative benefits” ([1], p. 176). Lewellen also has recently examined the problem because he felt that there “is something at least vaguely disturbing about the associated write-down of the present value of cash outflows for risk” ([7], p. 1332). Lewellen, however, concluded that “the standard procedure used for inflows can therefore be transferred intact. The logic is symmetric because the sign of the flows is reversed.” In a comment on Lewellen, Celec and Pettway stated that they are “in substantial disagreement with Lewellen's development as well as with any implied generality of employing the standard RADR procedure in valuing cash outflow streams” ([3], P. 1061). This inappropriateness of the standard RADR approach to valuing cash outflows seems to have been accepted in the 1iterature. Kudla [6] recently claimed that it has been proved by the above authors and others that the normative rules in capital budgeting do not hold in evaluating cash outflows.

Date: 1982
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