MATHEMATICAL PROGRAMMING, THE CAPITAL ASSET PRICING MODEL AND CAPITAL BUDGETING OF INTERRELATED PROJECTS

THE PROBLEMS OF CAPITAL BUDGETING seem to be, figuratively speaking, everyone's concern. Industrial engineers, economists, operations research analysts and finance specialists claim the subject matter as their domain. Each has a unique perspective and point of view; each tends to concentrate attention on a different type of problem because of slightly different goals; each tends to use a different set of tools and techniques; and each tends to talk among themselves. The literature has grown rapidly in each field and has tended to diverge from, rather than to converge to, a unified whole. The analysis of uncertainty in capital budgeting is a good example. With some oversimplification, it is convenient to characterize the engineeringmanagement science approach as one concerned primarily with norinative. models for decision making and to be primarily concerned with computing solutions. Weingartner [17], Naslund [13], Hillier [7], Oakford [14] and Bernhard [2] are examples. These approaches place minimum emphasis on the development of criteria and maximum emphasis on solution technique. Mathematical programming holds sway in these approaches. The economics-finance approach tends to pay little attention to computing technique and a great deal of attention to the development of general criteria and rules. Here the theoretical ideas of capital asset pricing of Sharpe [15], Lintner [8], and Mossin [1 1] serve as background for capital budgeting analysis by Litzenburger and Budd [9], Hamada [6], Stapleton [16] and Bierman and Hass [3], to name a few. One could further classify the approaches as being concerned with the selection of sets of projects under inter-relationships in the engineering-management science approach and with single projects in the economics-finance approach. Mutually exclusive, contingent, competitive and complementary projects are significant in the writings of the former, while they play a lesser role in the latter. What is the appropriate discount rate or the hurdle rate that projects must clear is usually the goal of the economics-finance approach, while this rate is taken for granted in the engineering-management science approach. The classifications that have been made are not perfect, to be sure. Weingartner [17], Baumol and Quandt [1], Naslund [13] and Bernhard [2], represent programming approaches which tie in with the criterion problem. Hamada [6] on the opposite side makes reference to programming analysis in his development of general criterion and rules for capital budgeting. However, explicit recognition of the role of programming in the general criterion of market value maximization using the capital asset pricing model has not been detailed.