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Improving Capital Budgeting Through Probabilistic Approaches

Oualid Benallou and Rajae Aboulaich ()
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Oualid Benallou: Laboratory of Study and Research in Applied Mathematics, Mohammadia School of Engineering, Mohammed V University, Rabat, Morocco
Rajae Aboulaich: Laboratory of Study and Research in Applied Mathematics, Mohammadia School of Engineering, Mohammed V University, Rabat, Morocco

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2017, vol. 20, issue 03, 1-21

Abstract: This article advocates the multiple benefits of applying probabilistic approaches to capital budgeting through enriching the deterministic framework with a stochastic modeling of main impacting inputs (including a methodology for selecting the most important inputs to be modeled stochastically). The essential limitations of the deterministic capital budgeting methodology are presented: behavioral biases (optimism, asymmetric probability distribution, etc.), incomplete view of the risk return profile, neglecting real options (be it to evaluate a project or to reshape it in a value creation perspective), portfolio diversification impact, etc. Through some selected examples, we illustrate how each of these limitations can be mitigated thanks to probabilistic approaches leading to a better decision-making process and ultimately more value creation.

Keywords: Probabilistic approaches; capital budgeting; variability impact; risk return profile; behavioral economics; net present value at risk (NPV@Risk) (search for similar items in EconPapers)
Date: 2017
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