Most companies use discounted-cash-flow (DCF) methods to evaluate capital budgeting decisions.

The methods typically assume that a projects initial cash outlay (ICO) is known with certainty. However, many types of initial outlays have substantial uncertainty, especially those involving the construction of a new facility. This risk affects not only the ICO, but it also affects subsequent depreciation tax shields. A proper capital budgeting analysis should incorporate the additional risk that is due to an uncertain ICO. We have seen that neither the typical practices employed by corporations nor two common techniques advocated in the finance literature, riskadjusted discount rates and certainty equivalents, satisfactorily address ICO risk. Sensitivity analysis is an effective way to address ICO risk, but the adjustments needed to satisfactorily address ICO risk is often overlooked within a sensitivity analysis. We could fill this gap by showing the impact of ICO risk on the standard deviation of a projects NPV. We can then apply sensitivity analysis with the appropriate adjustments to illustrate the impact of ICO risk.