Capital budgeting under uncertainty - An integrated approach using contingent claims analysis and integer programming

Recently the application of contingent claims analysis and dynamic programm ing to project evaluation has attracted a let of attention. These technique s are required, for example! if the value of a project develops stochastica lly over time and the decision to invest into this project can be postponed . Yet. so far there are no considerations regarding how this perception of projects reflects on a capital budgeting situation. We propose two approach es that integrate these methods with traditional capital budgeting, models. A simple capital budgeting model can be formulated as the problem of findi ng time portfolio of options that has maximal value and fulfils the capitol expenditure constraint. However, this model has some shortcomings regardin g its applicability in traditional budgeting situations. Therefore, we defi ne an alternative optimisation model that uses scenarios to depict a set of possible future states. The optimal portfolio is then equivalent to a dyna mic investment strategy that determines a number of state-dependent optimal portfolios.