Economic evaluation of investment projects under uncertainty: A probability theory perspective

In the current competitive economy, the investors are facing increased uncertainty while evaluating new investment projects. This uncertainty caused from existence of insufficient information, oscillating markets, unstable economic conditions, obsolescence of technology and so on, and hence uncertainty is inevitable in reality. In such conditions, the deterministic models, while easy to use, do not perfectly represent the real situations and might lead to misleading decisions. When the cash flows for an uncertain investment project, over a number of future periods, are discounted using the traditional deterministic approaches, it may not provide investors with an accurate estimation of the project value. Therefore, this paper utilizes the probability theory tools to derive closed-form probability distribution function (PDF) and related expressions of the net present worth (NPW), as a useful and frequently used criterion, for cost-benefit evaluation of projects. The random cash flows follow normal, uniform or exponential distributions in our analysis. The probability distribution function of the NPW is an important tool that helps investors to accurately estimate the probability of being economic for projects, and hence, it is important tool for investment decision-making under uncertainty.