The Equity Decision
The risk and reward of a proposed investment are measured by projecting the financial performance of the investment in an assumed business environment. Although there are various means of measuring risk and reward, the assessment of performance is only as valid as the appropriateness of the modeling of the business environment and the performance of the investment in such an environment. No model, no matter what its degree of complexity, can be validated as the right model to be used under the particular circumstances surrounding the investment because all models are approximations and simplifications of reality. No model can incorporate the infinite number of threads that make up the web of economic reality. The use of models is a testament that reality is too complex to be dealt with directly. We resort to models because we cannot deal with reality on reality's terms.
Nor, for that matter, can assessments of future business conditions and the financial performance of an investment be validated. Assessments are judgments of events before the fact. Validation of assessments would involve a comparative analysis of what is assumed to occur with what actually occurs. Such a comparison can only be made some time after the making of the decision. By then, it is too late to change the decision. Assessments cannot be validated before the fact. If assessments could be validated, then the assessments are no longer assessments, but facts. When dealing with facts, there is no such thing as risk analysis because risk analysis deals with uncertainty.
The future is fraught with uncertainty. Nevertheless, the decision whether to invest in a project demands that some assessment be made of the general business climate and how the project may fare within the prevailing pattern of business activity. Even if such assessments are pure conjecture, these assessments are necessary as a prop in the drama of the making of a business decision. The