Title: Valuing Risky Projects with Contingent Portfolio Programming
Authors: Janne Gustafsson
Cheyne Capital Management Limited
Stornoway House, 13 Cleveland Row, London SW1A 1DH, U.K.

Ahti A. Salo
Systems Analysis Laboratory
Helsinki University of Technology
P.O. Box 1100, FIN-02015 HUT, Finland
Date: June, 2005
Status: Systems Analysis Laboratory Research Reports E18 June 2005

This paper examines the valuation of multi-period projects in a setting where (i) the investor maximizes her terminal wealth level, (ii) she can invest in securities and private investment opportunities, and (iii) markets are incomplete, i.e. the cash flows of private investments cannot necessarily be replicated using financial securities. Based on Gustafsson and Salo’s (2005) Contingent Portfolio Programming, we develop a multiperiod mixed asset portfolio selection model, where project management decisions are captured through project-specific decision trees. This model properly captures the opportunity costs imposed by alternative investment opportunities and determines the appropriate risk-adjustment to the projects based on their effect on the investor’s aggregate portfolio risk. The project valuation procedure is based on the concepts of breakeven selling and buying prices, which require the solution of mixed asset portfolio selection models with and without the project being valued. The valuation procedure is demonstrated through numerical experiments.

Keywords: project valuation, mixed asset portfolio selection, contingent portfolio programming