OVERVIEW

To invest or not to invest? is a question pondered over every day by business executives across the globe. They are frequently faced with the dilemma of deciding whether or not to invest in developing a new product, introducing a new technology, testing a new drug, or launching a new service, to name just a few examples. Although the decision to invest in a project depends on several factors, it is primarily dictated by the expected financial return and risk associated with that project. The expected return is represented by the net payoff from the project, typically expressed in today s dollars as a present value, and the risk is represented by the uncertainty associated with that payoff. The most important and commonly used metric in the decision-making process is the net present value (NPV), which is the difference between the present value of the expected payoff and the project investment. If the project NPV is significantly positive or significantly negative (the expected payoff is significantly greater or smaller than the investment cost), the decision to invest or not to invest, respectively would be slam-dunk, especially when the payoff is deterministic and represented by one value. However, because of the uncertainty related to the commercial success of the associated product or service, the payoff is probabilistic, with a wide range of possible values. Even with a probabilistic payoff, the decision would be slam-dunk if the whole range of the expected payoff values is either far higher (Figure 9-1A)...