Investment evaluation under uncertainty

* Evaluation of future cash flows under conditions of certainty is well known; it leads to the "discounted present value" method. This paper shows that maximization of expected utility is a very restrictive method of expressing one's attitude to risk. Most businessmen would judge it unreasonable once it is explained to them what this method really implies. By using a preference ordering, which is not equivalent to any utility function, and by focusing attention on the possibility of unpredictable "disasters" in the future, we develop a new method of investment evaluation. Qualitatively, the new approach turns out to be very similar to the one used by businessmen, and not at all similar to discounted present value. We give an example of two projects, A and B, where A is preferred to B by the discounted present value method at all values of the discount rate, but A is inferior to B by the new evaluation. The discussion in the body of this paper is literary. All the mathematics is contained in appendices and can be skipped by the non-mathematical reader. Introduction and Notation