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Techniques for Treating Uncertainty and Risk in the Economic Evaluation of Building Investments.


pdf icon Techniques for Treating Uncertainty and Risk in the Economic Evaluation of Building Investments. (7381 K)
Marshall, H. E.

NIST SP 757; 97 p. September 1988.

Available from:

Government Printing Office

Keywords:

building economics; certainty equivalent; decision making; economics; mathematical/analytical technique; risk-adjusted discount rate; risk analysis; risk attitude; risk exposure; sensitivity analysis; simulaiton; uncertainty

Abstract:

Four economic methods - life-cycle costing, net benefits, benefit-cost ratio, and adjusted internal rate of return - are illustrated in a building investment problem. Input values are first assumed to be certain; thus uncertainty and risk are ignored in arriving at measures of project worth. Then the same four methods are examined with techniques for treating uncertainty in input values and for measuring risk exposure (i.e., the probability of failing to achieve preducted investment worht). Risk attitude, the willingness of a decision maker to take a chance or gamble on an investment of uncertain outcome, is also incorporated. Techniques examined include conservative cash flow estimation, sensitivity analysis, breakeven analysis, risk-adjusted discount rate, certainty equivalent, input estimation using expected values, mean-variance criterion and coefficient of variation, decision analysis, simulation, and the mathematical/analytical technique. Advantages and disadvantages of each technique are described. The techniques are applicable to any capital budget expenditure whose future stream of benefits, revenues, savings, or costs is uncertain. Guidance is provided for selecting the appropriate technique for any given investment problem.