Cost Benefit Analysis with Uncertain Cash Flow and Project Life

Abstract

When future cash flows and the lives of capital projects are known, the optimal solution is usually one of choosing the project that maximizes net present value of future returns on the project. In many situations, however, the information needed for cost‐benefit analysis is not known with certainty. Recent cost‐benefit models have tried to introduce some realism by assuming future cash flows are unknown but are subject to known probability laws. However, not much has been done on relaxing the assumption of known project life. This paper proposes a framework to include the assumption of uncertain project life and future cash flows in cost‐benefit decision making. The method follows from some known techniques from the actuarial literature that to a large extent is underappreciated in cost‐benefit analysis.