SOUTHERN JOURNAL OF AGRICULTURAL ECONOMICS DECEMBER, 1976 USE OF PROBABILISTIC CASH FLOWS IN ANALYZING INVESTMENTS UNDER CONDITIONS OF RISK AND UNCERTAINTY*

Managers of business firms, large or small, farm We illustrate the methodology for a nonfarm invest-or nonfarm, must make investment decisions under ment decision and suggest how it may be applied for conditions of risk and uncertainty. However, in agricultural investment decisions. evaluating investments, the assumption of perfect knowledge has often been used to simplify the ALTERNATIVE APPROACHES TO analysis. For example, an estimate of average annual IN R RA A CET T net returns is frequently discounted into perpetuity to evaluate a real estate investment alternative. The concept of expected net returns represents Capital budgeting literature suggests a number of an attempt to recognize the probabilistic nature of approaches to evaluating alternative investments. annual net returns for an investment under conditions However, use of concepts such as the payback period, of uncertainty [8]. Expected annual net return is average rate of return, internal rate of return and net calculated by weighting annual net returns by the present value embodies the assumption of perfect probability of their occurrence and by summing over knowledge. all levels of return. Since businessmen seldom kno