Which one of the following is not an investment appraisal technique to incorporate risk and uncertainty?
Marginal Efficiency of Capital approach
Investment appraisal under risk and uncertainty uses techniques that build the variability of future outcomes into the decision. The question asks which listed item is not such a technique.
The Marginal Efficiency of Capital (MEC) approach is not a risk-incorporating appraisal technique. MEC is a Keynesian macroeconomic concept - the rate of discount at which the present value of the expected returns from a capital asset equals its supply (replacement) price. It is used to explain the overall level of investment in the economy and its relation to the interest rate, not to adjust an individual project's appraisal for risk.
By contrast, the other three are genuine tools for handling risk and uncertainty. The pay-off matrix arrays the outcomes of each alternative against the possible states of nature, allowing criteria like expected value or maximin. The certainty-equivalent approach converts each risky cash flow into the smaller certain amount a decision-maker would accept in its place, then discounts at the risk-free rate. The decision-tree method maps sequential decisions and chance events with their probabilities to compute expected values along each branch.
Since only the MEC approach is not a device for appraising projects under risk, it is the odd one out.
Hence the technique that is not for incorporating risk and uncertainty is the Marginal Efficiency of Capital approach.
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