Investment Decision Making Using Optional Models

In order to create value, companies must allocate their resources effectively and evaluate investment alternatives. This book examines, from a theoretical and empirical point of view, how managerial flexibility can be integrated into investment decisions through the optional approach. Unlike the traditional net present value method, the actual options take into account indeterminate elements. These lead to unpredictable cash flows at the time of the investment decision, especially in the context of complex and risky projects. The book puts into perspective the use of optional models and their interactions. The different categories of options are the subject of practical applications, through analysis of investment decisions where uncertainty is growing. Therefore, studies make it possible to consider the flexible nature of investment choices by integrating new information and risk over time.

This book presents a new approach to the valuation of capital asset investments and investment decision-making. Starting from simple premises and working logically through three basic elements (capital, income, and cash flow), it guides readers on an interdisciplinary journey through the subtleties of accounting and finance, explaining how to correctly measure a project’s economic profitability and efficiency, how to assess the impact of investment policy and financing policy on shareholder value creation, and how to design reliable, transparent, and logically consistent financial models. The book adopts an innovative pedagogical approach, based on a newly developed accounting-and-finance-engineering system, to help readers gain a deeper understanding of the accounting and financial magnitudes, learn about new analytical tools, and develop the necessary skills to practically implement them. This diverse approach to capital budgeting allows a sophisticated economic analysis in both absolute terms (values) and relative terms (rates of return), and is applicable to a wide range of economic entities, including real assets and financial assets, engineering designs and manufacturing schemes, corporate-financed and project-financed transactions, privately-owned projects and public investments, individual projects and firms. As such, this book is a valuable resource for a broad audience, including scholars and researchers, industry practitioners, executives, and managers, as well as students of corporate finance, managerial finance, engineering economics, financial management, management accounting, operations research, and financial mathematics. It features more than 180 guided examples, 50 charts and figures and over 160 explanatory tables that help readers grasp the new concepts and tools. Each chapter starts with an abstract and a list of the skills readers can expect to gain, and concludes with a list of key points summarizing the content.

This book is devoted to investment decision-making under uncertainty. The book covers three basic approaches to this process: the stochastic dominance approach; the mean-variance approach; and the non-expected utility approach, focusing on prospect theory and its modified version, cumulative prospect theory. Each approach is discussed and compared. In addition, this volume examines cases in which stochastic dominance rules coincide with the mean-variance rule and considers how contradictions between these two approaches may occur.

In the past, corporate investment decisions were cut and dried. Buy a new machine that is more efficient, make more products costing a certain amount, and if the benefits outweigh the costs, execute the investment. Hire a larger pool of sales associates, expand the current geographical area, and if the marginal increase in forecast sales revenues exceeds the additional salary and implementation costs, start hiring. Need a new manufacturing plant? Show that the construction costs can be recouped quickly and easily by the increase in revenues the plant will generate through new and improved products, and the initiative is approved. However, real-life business conditions are a lot more complicated. Your firm decides to go with an e-commerce strategy, but multiple strategic paths exist. Which path do you choose? What are the options you have? If you choose the wrong path, how do you get back on the right track? How do you value and prioritize the paths that exist? You are a venture capitalist firm with multiple business plans to consider. How do you value a start-up firm with no proven track record? How do you structure a mutually beneficial investment deal? What is the optimal timing to a second or third round of financing? This chapter provides a novel approach to applying real options to answering these issues and more.

This book provides an introduction to investment appraisal and presents a range of methods and models, some of which are not widely known, or at least not well covered by other textbooks. Each approach is thoroughly described, evaluated and illustrated using examples, with its assumptions and limitations analyzed in terms of their implications for investment decision-making practice. Investment decisions are of vital importance to all companies. Getting these decisions right is crucial but, due to a complex and dynamic business environment, this remains a challenging management task. Effective appraisal methods are valuable tools in supporting investment decision-making. As organisations continue to seek a competitive edge, it is increasingly important that management accountants and strategic decision-makers have a sound knowledge of these tools.