Utility Theory: It is based on economic theory of marginal utility which means a satisfaction we gain from consuming an additional unit of a product . Law of diminishing marginal utility is also applied here but the difference is money can never be zero. The utility increasing with increase in money (so you can start fulfilling your basic needs and also your future needs) after reaching a certain point the utility of money start decreasing (at this point your all needs are fulfill) now money is less valuable for you in comparison to earlier stage. This function is useful for those investors who consider more risk. It is not used by risk averse investors who protect his investment from high risk. Example: According to below information of a 3 projects A, B and C and its cash inflows. Find out the without utility of cash flows and with utility cash flows. PROJECT A Year Cash inflow Probability 1 30000 0.3 2 20000
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