The multinational firms' bias for risky capital projects

In practice, many multinational firms use a discounted cash flow (DCF) approach when making capital investment decisions. A paper contends that present values of net cash flow (NCF) become biased when cash outflows are discounted at any rate higher than the risk-free rate. This bias favors the accep...

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Bibliographic Details
Published in:Multinational business review 1997-10, Vol.5 (2), p.10
Main Authors: Tole, Thomas M, Hand, John H, McCord, Sammy O
Format: Article
Language:English
Subjects:
Bias
Capital budgeting
Capital investments
Discount rates
Discounted cash flow
Mathematical models
Multinational corporations
Net present value
Present value
Risk premiums
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Summary:In practice, many multinational firms use a discounted cash flow (DCF) approach when making capital investment decisions. A paper contends that present values of net cash flow (NCF) become biased when cash outflows are discounted at any rate higher than the risk-free rate. This bias favors the acceptance of risky projects. To compensate for this bias, a paper suggests: 1. subtracting risk premiums for risk-free rate when discounting uncertain cash outflows, or 2. in the case of long-term projects in high risk classes, determining the dollar reduction in present value (PV) caused by discounting positive risky cash flows and then subtracting the same dollar amount from PV for negative cash flows in the same risk class.
ISSN:1525-383X
2054-1686