Investment Decisions in Uncertainty

Abstract

The aim of this chapter is to take risk into account in investment decisions. Up to now, we have assumed that all calculation elements are known with certainty, both when applying the static and dynamic investment calculation methods in Chaps. 2 and 3, and when making investment programme decisions in Chap. 4 and investment duration decisions in Chap. 5. This is, of course, only true in very rare cases. For example, if we consider a savings bond with a fixed interest rate as a form of financial investment and hold it for the entire term, then from a practical point of view all calculation elements are known with certainty for the entire term. Some theoretical concerns about this view should be ignored here. If, in the context of a comparison of alternatives, this financial investment is to be compared with an operational investment, in which, for example, a new branch of industry is to be established in the company, it usually makes no sense to compare the two classically determined net present values considering fictitious investment and the removal of the reinvestment premise. The probability that the data of the planned operational investment will occur exactly as planned is much lower. Even if the investment data were planned very elaborately and are based on industry information and experts, the residual value of a production facility is, for example, much more difficult to determine than the repayment amount of a fixed-rate savings bond. This was already indicated in Sect. 1.9. In the case of two equal net present values or other target values of the dynamic investment calculation methods, the rational investment decision of a cautious businessman would certainly be to invest in the safe savings certificate instead of the investment alternative with the same net present value, which, however, would be more likely to deviate from the planned value. But what should the rational investment decision be if the net present value of the safer investment is less than the net present value of the more uncertain alternative? This chapter deals with the rational decision of the investor in such a situation.