Risk And Reward In Capital Budgeting

One of the problems in capital budgeting is that we are dealing with projections about the future, which are particularly troublesome. Scenario analysis allows us to examine the best-case and worst-case values of a project. In a recent article, two questions are posed about a new project or acquisition: 1) How much can the firm afford to invest to achieve its goals? and 2) How much is the firm prepared to lose? Both of these must be answered before a firm undertakes a new project. Importantly, the firm must to be able to accurately estimate potential losses and be aware that these losses may be realized.