Probabilistic cash flows and equivalent discount rates

Abstract

Many authors have studied probabilistic cash flows in recent years. They have introduced analytical methods which determine the probability distribution function of the net present value and internal rate of return of a series of random discrete cash flows; considered serially correlated cash flows and the uncertainty of future capital investment and reinvestment rates; and presented formulas for benefit-cost ratio for probabilistic cash flows. Others have studied the arithmetic of inflation corrections in evaluating real present values. Here, the expected value and the variance of a probabilistic cash flow are obtained by means of moments. Assuming that cash flows are probabilistic because only future discount rates (involving inflation, risk and other factors) are uncertain, we calculate the mean level of future discount rates equivalent to the risk degree in probabilistic cash flows. A numerical example is given.