A mean-risk index model for uncertain capital budgeting

Qun Zhang, Xiaoxia Huang and Chao Zhang
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Qun Zhang: University of Science and Technology Beijing, Beijing, China
Xiaoxia Huang: University of Science and Technology Beijing, Beijing, China
Chao Zhang: University of Science and Technology Beijing, Beijing, China

Journal of the Operational Research Society, 2015, vol. 66, issue 5, 761-770

Abstract: This paper discusses the capital budgeting problem of projects using annual cash inflows, cash outflows and initial investment outlays given by experts’ evaluations when no historical data are available. Uncertain variables are used to describe the projects’ parameters. A profit risk index and a capital risk index are proposed, and a mean-risk index model is developed for optimal project selection. In addition, the deterministic forms of the model are given and a solution algorithm is provided. For the sake of illustration, a numerical example is also presented. The results of the example show that both profit risk index and capital risk index are important in investment risk control. However, when the profit risk control requirement is strong, the selected project portfolio may be insensitive to the capital risk constraint; when the profit risk control requirement is moderate, the capital risk constraint plays an important role. The results also show the tendency that when either the tolerable profit risk level or the tolerable capital risk level becomes higher, the obtained expected net present value of the project portfolio becomes larger, which is in agreement with the investment rule that the higher the risk, the higher the return.

Date: 2015
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