Capital-Budgeting Decisions Using "Crystal Ball"

Abstract

Crystal Ball, a software add-on to commercial spreadsheet programs, can be used to address many of the uncertainties surrounding capital-budgeting decisions. The difficulty in the capital-budgeting process stems from the difficulty of estimating the amount and timing of future cash flows. Unlike most traditional approaches that ignore uncertainty and rely instead on single, best-guess point estimates, the authors suggest ways to grapple with the probabilistic nature of capital-budgeting calculations by starting with a deterministic model that uses single-point estimates to analyze a typical capital-budgeting problem. The deterministic model assumes that all of the inputs are known with certainty and each input is represented by a single-point estimate. Simulation software is then used to replace the single-point estimate in each cell of the model with the appropriate probability-density function, or a distribution of most-likely values.