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This chapter shows how the firm can make optimal marketing decisions after allowing for the effects of competitive reaction. It considers multiproduct firms, explicitly allow for cost and demand uncertainty, distinguish between different behavioral modes for the firm, and show how the firm should adapt its marketing decisions when new information becomes available to it or to its competitors in the future. In particular, it shows how the firm can use marketing-finance fusion to make optimal decisions after simultaneously allowing for competitive reaction and the arrival of new information.

This chapter introduces key financial tools necessary for measuring the long-run effects of marketing policy under uncertainty. It distinguishes the cases where the firm sells multiple products or has multiple divisions. Specifically, it analyzes how the firm can evaluate the effects of strategic flexibility in decision making; in particular, it shows how the firm can use the real options methodology to measure and reward managers so that they focus on long-run performance.

This chapter provides a basic framework for appraising the overall feasibility and bankability of a term loan proposal. It presents certain tools of analysis that lender that could be used to make a comprehensive assessment of a project by banker. It discusses key concepts such as net present value, internal rate of return, pay back method, and effective rate of return.

This chapter presents telling evidence that the value of a firm is not the net present value of its expected profits. This is a provocative statement, and deserves careful support: the notion that the value of investments in firms is the expected net present value of their earnings is a pillar of Finance. The author summarizes the intellectual history of this notion, and then presents six major failings of the “NPV rule,” in particular, that decision-makers often don’t follow this rule.

This chapter demonstrates the importance of management flexibility regarding the timing, scale, and type of investments, which is the basis for the study of “real options.” The chapter describes an opportunity and its contractual equivalent, an option, the history of option contracts, the classic Black-Scholes-Merton option model of the firm, and the formula for pricing, under ideal conditions, a pure financial call option. From this basis, the author draws the conclusion that the existence of an option premium alone renders invalid the Net Present Value rule for the value of the firm. The author then describes techniques for valuing “real options,” including extensions of financial options methods, Decision Tree Analysis, Monte Carlo, stochastic control, and value functional models, and “good deal” bounds. Finally it describes a recently-proposed synthesis of traditional income methods and real options analysis, which the author calls “expanded net present value” or XNPV.

This chapter examines a model in which the exogeneous rate of return of capital is constant but random. Safe investment projects must be evaluated and implemented before this uncertainty can be fully revealed, i.e., before knowing the opportunity cost of capital. A simple rule of thumb in this context would be to compute the net present value (NPV) for each possible discount rate, and to implement the project if the expected NPV is positive. If the evaluator uses this approach, this is as if one would discount cash flows at a rate that is decreasing with maturity. This approach is implicitly based on the assumptions that the stakeholders are risk-neutral and transfer the net benefits of the project to an increase in immediate consumption. Opposite results prevail if one assumes that the net benefit is consumed at the maturity of the project.

This chapter reviews the findings of published surveys of corporate executives showing the project evaluation methods used in capital budgeting. The chapter compares the findings to the theoretically correct methods described and recommended in the academic literature. The goals are to identify past trends, ascertain current practices, and evaluate the existing gap between theory and practice. A major area of investigation concerns the use of various capital budgeting techniques (e.g. net present value, internal rate of return, and payback period). Other important areas of investigation include measuring and adjusting for project risk, using capital rationing, selecting hurdle rates, and conducting post audits. Additional survey research topics discussed include how firms measure project benefits, how firm goals relate to capital budgeting methods used, how firms consider future inflation in capital budgeting analysis, the use of real options, and methods of estimating residual value. While most studies discussed here focus on large U.S. firms, many focus on non-U.S. firms, multinational firms, multi-division firms, and small firms.

Single-period performance measures made popular by VBM vendors for the evaluation of a firm's ongoing operations can easily be misinterpreted and misused to evaluate period-by-period performance of new investment opportunities. Nothing is wrong with single-period measures of performance per se (e.g., EVA); the problem lies in the use of such measures as indicators of value-creation potential for long-lived projects. In this situation it is best to simply use project NPV, which, furthermore, is completely consistent with EVA when the present value of all future project EVA is considered. The chapter also discusses a modification of EVA that corrects for the problems that arise in the use of traditionally defined EVA in project analysis. However, the fix comes at a high cost in terms of the required information inputs.

This chapter first illustrates the notion of an option value with a simple numerical example, before examining a more sophisticated application with a Poisson two-armed bandit. In the first case, there is an option value to wait. In the second case, there is an option value to experiment. The theory of real option value has the objective to adjust the standard cost-benefit methodology, which is static by nature, in order to integrate these dynamic aspects of the evaluation problem. The computation of option values must be done by backward induction. At each node of the decision tree, the optimal decision is made by taking into account the optimal decisions in the subsequent nodes of that part of the tree.

This concluding chapter summarizes the principles set forth in this volume. It argues that the discount rate is a key parameter in economics because it determines how our societies value their future. The chapter aims to use the discount rate in the net present value (NPV) decision rule: to find the discount rate which gives a positive NPV only for those projects that raise the sum of present and future generations’ felicity. In that light, this chapter briefly touches upon the basic principles of discounting, the discounting of safe real cash flows, the term structure of real discount rates, the evaluation of uncertain projects, and the adaptability of projects.

This chapter examines the role of time, risk, and investment in the determination of net present value (NPV) and options. It explains that the NPV of a project is the sum of its receipts discounted for the passage of time, with outlays being counted like negative receipts. The problem with the conventional NPV criterion is that it considers only two alternatives: one where a project is begun immediately and carried out to completion, the other where the project is never undertaken. It fails to provide the options to either delay or abort a project which may be required to ensure the profitability of a project. This chapter provides several relevant computational exercises and solutions.

Four alternative approaches to program evaluation are discussed: the traditional Griliches/Mansfield method, the counterfactual method, the spillover method, and non-economic based methods. Each is discussed from a conceptual point of view. Also, the mathematics underlying evaluation metrics is set forth; these metrics include the internal rate of return, benefit-to-cost ratio, and net present value.

The author traces the importance of the business, company, or firm in Economics, society, and world history over two millennia. The author notes that, given its importance and centrality in modern economies, there should be a well-developed theory of the firm that pervades both Economics and Finance. However, a series of “quandaries” are posed that illustrate that this is not the case. These include the fact that neoclassical economics essentially ignores the firm, that mainstream Economics largely ignores the entrepreneur, and that real entrepreneurs do not maximize profits. Furthermore, much of Finance focuses on publicly-traded firms, while 99% of firms are privately held, and mathematical finance often assumes complete markets, which are a rarity in the actual world. These provocative statements motivate much of the theory and applications developed in the rest of the book.

Chapter 6 examines the value of environmental assets, which lies in the discounted stream of services they offer. Their conservation depends on the expected rate of change in their value, if conserved, relative to the rate of return on alternative assets. This chapter considers how the portfolio of environmental assets—natural capital—has been valued at the national scale. The two main approaches adopted are the United Nations’ System of Environmental-Economic Accounts (SEEA), and the World Bank’s (Inclusive) Wealth Accounts. The authors consider both approaches, and what they mean for the sustainability and the efficiency of natural resource use. Particular attention is paid to the residual left over after taking account of all marketed inputs in production: total factor productivity.

This chapter discusses how to attach value to technology options. One needs to address the balance between investing in getting better at what you are already doing versus investing in doing new things. There are numerous high-profile examples of companies unsuccessfully addressing this balance, leading to their eventual demise. Technology and process investments create contingent opportunities for later solutions; they are contingent in the sense that they may not emerge. Many markets are inherently laced with uncertainties. If a company is better at managing uncertainty than its competitors are, high profits can result. Strategic value is the sum of the net present value of current lines of business, and the net option value of aspirational lines of business. Options-based thinking can provide a framework for value-centered organizations by characterizing value, assessing value, and managing value.

It is commonly said that mineral exploration is a risky business, but what does that really mean? Although exploration can be financially rewarding, there is a high probability that a single venture will be a failure. Risk is defined as chance of failure or loss and its adverse consequence (i.e., failure or loss). Risk differs from uncertainty in that uncertainty simply means lack of knowledge of the outcome or result, whereas risk involves a loss. Thus, one could be uncertain of an outcome, but not necessarily be at risk of losing something. In risk analysis, two quantities are estimated: the magnitude (severity) of the possible adverse consequence(s), and the likelihood (probability) of occurrence of each consequence. Procedures of risk analysis are well established, if not simple, and are applied in both business and engineering (Aven, 2003; Bárdossy and Fodor, 2004; Davis and Samis, 2006). Mineral exploration is an economic activity involving risk and uncertainty, so risk also must be defined in an economic context in which the extent of the loss is defined. Successful mineral exploration strategy requires identification of some of the risk sources and consideration of them in the decision-making process so that controllable risk can be reduced. It is not uncommon to see recommendations that exploration firms should accept all projects with positive expected monetary values—that is, projects that have a positive economic value after being multiplied by the probability of deposit discovery and subtraction of exploration costs. Clearly, this strategy would be unwise for a firm with limited resources if the chance of failure were significant. Both expected monetary values and the probabilities of various outcomes such as economic failure should be considered in the decision-making process. Because economic return, when measured by net present value, is closely related to the size of mineral deposits, and because deposit sizes can be represented by highly skewed frequency distributions, achieving expected monetary or higher values tends to be a low-probability outcome. This and the typical rareness of mineral deposits are the fundamental reasons for the high risk in mineral exploration.

Estimated undiscovered mineral resources are based on grade-and-tonnage models made up of deposits of varying economic viability (chapter 6). Many deposits used in grade-and-tonnage models have not been developed because they cannot yet be mined economically. Although technological advances act over time to lower mining costs and environmental impacts, thereby allowing formerly uneconomic deposits to become operating mines, some deposits in these models might “never” be mined for one or more of a variety of reasons, including relatively low tonnages and grades, deep burial, or occurrence in or near environmentally sensitive areas. Few nonacademic problems related to mineral resources are resolved by knowing the amount of metal that exists in some piece of land. Mineral policy issues and problems typically revolve around the effects of minerals that might be economically extracted. This is true if the problem concerns exploring or developing minerals, values of alternative uses of the land, or environmental consequences of minerals development. In resource assessments of undiscovered mineral deposits and in the early stages of exploration, including planning, a need for prefeasibility cost models exists. In exploration, these models separate economic from uneconomic deposits to help focus on targets that can benefit the exploration enterprise. In resource assessment, these cost models can be used to eliminate deposits that would probably be uneconomic even if discovered and allow estimation of the social value of the resources. Data used in grade-and-tonnage models do not necessarily represent economic deposits. Many of the deposits used in the models were found not to be economic and were not mined, whereas other deposits were mined long ago under economic conditions that no longer exist. In this chapter we briefly explore some alternative measures of value used in assessments and then develop the basis for simplified economic filters to separate the clearly economic from the clearly uneconomic deposits. The equations used are not difficult, but they require care in their application because many of the apparently small cost factors can have large effects on the final economic discrimination.

The chapter explores the processes of official decision-making regarding conversion of forests to non-forest use post the enactment of the Forest Conservation Act (FCA), 1980 in India. It seeks to analyse the design and objectives of the FCA by illustrating the regulatory trajectory of a few high profile industrial and infrastructure projects. The chapter also looks at the systems of compensation and valuation, institutionalized through the practice of legal forest diversions. It further examines the interaction between FCA and the 2006 legislation for the recognition of forest rights of tribal and forest dwelling communities. In conclusion, the chapter reflects on the principles, which have shaped legal and policy processes that regulate land use change in forest ecosystems.