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Improving Capital Budgeting Through Probabilistic Approaches

Author

Listed:
  • 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)

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.

Suggested Citation

  • Oualid Benallou & Rajae Aboulaich, 2017. "Improving Capital Budgeting Through Probabilistic Approaches," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 20(03), pages 1-21, September.
    • Handle: RePEc:wsi:rpbfmp:v:20:y:2017:i:03:n:s0219091517500187
    DOI: 10.1142/S0219091517500187
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    References listed on IDEAS

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    1. Luban F., 2002. "An Integrated Investment Decision Analysis Procedure Combining Simulation and Utility Theory," European Research Studies Journal, European Research Studies Journal, vol. 0(1-2), pages 23-36, January -.
    2. Binder, John J & Chaput, J Scott, 1996. ""Error Correction": A Positive Analysis of Corporate Capital Budgeting Practices," Review of Quantitative Finance and Accounting, Springer, vol. 7(3), pages 307-307, November.
    3. Mufaddal Baxamusa, 2012. "The Relationship between Underinvestment, Overinvestment and CEO's Compensation," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 15(03), pages 1-26.
    4. Victor Dragota & Lucian Tatu & Daniel Pele & Nicoleta Vintila & Andreea Semenescu, 2010. "Capital budgeting: the Romanian university professors' points of view," The Review of Finance and Banking, Academia de Studii Economice din Bucuresti, Romania / Facultatea de Finante, Asigurari, Banci si Burse de Valori / Catedra de Finante, vol. 2(2), pages 95-102, December.
    5. Goran Karanovic & Bisera Gjosevska, 2012. "Analysis of Risk and Uncertainty Using Monte Carlo Simulation and its Influence on Project Realization," Annals - Economic and Administrative Series -, Faculty of Business and Administration, University of Bucharest, vol. 6(1), pages 145-162, December.
    6. Binder, John J & Chaput, J Scott, 1996. "A Positive Analysis of Corporate Capital Budgeting Practices," Review of Quantitative Finance and Accounting, Springer, vol. 6(3), pages 245-257, May.
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