Decision Support Tools: A Glossary
Conventional capital-budgeting tools
These tools use the estimated incremental cash flows from potential investments to establish whether a project is worth being funded through the firm’s capitalization structure. They include discounted cash flow, expected rate of return, and net present value models.
Quantitative multiple scenario tools
These tools analyze decisions by fully specifying possible outcomes and their probabilities. They use mathematical, statistical, and simulation methods to identify the risk/return properties of possible choices. The tools include:
• Monte Carlo methods, which use computational algorithms that rely on repeated random sampling to obtain numerical results
• decision analysis, which uses outcome scenarios and probabilities to identify the best decision to make given different decision-maker objectives
• real options, which applies the concept of financial option valuation to “real” situations and allows managers to quantify the costs and benefits of flexibility when making decisions under uncertainty