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Expected values and standard deviations provided some useful figures, on the basis of which, a decision-maker should choose a project with a high expected value and a high standard deviation or a project with a comparatively low expected value and a low standard deviation. The risk preference of decision maker would depend upon his choice. In fact a rational decision-maker would maximize his utility. Thus he would accept the investment project, which yields maximum utility to him. Individuals and firm differ in their attitudes towards risk. In contrast to the approaches for handling rick discussed do far, utility theory aims at incorporation of decision procedure.

We can broadly divided risk in the following categories:

(i) Risk-averse investors attach lower utility to increasing wealth. For them the value of the potential increase in wealth is less than the possible loss from the decrease in wealth. In other words, for a given wealth (or return), they prefer less risk to more risk.

(ii) Risk-neutral investors attach same utility to increasing or decreasing wealth (or return).

(iii) Risk-seeking investors attach more utility to the potential of additional wealth to the loss from the possible loss from the decrease in wealth. For earning a given wealth (or return), they are prepared to assume higher risk.

The utility function for a risk-averse individual may resemble in which, the horizontal line represents the potential gain or loss in rupees and the vertical line represents the potential gain or the individual towards such gains and losses, as defined by his utility functions. The utility values’ measured on relative basis, are called ‘utile’ and are measured on an arbitrary scale. It is well established by many empirical studies that individuals are generally risk averters and demonstrate a decreasing marginal utility for money function.

The Utility Function may be similar to the one shown in because of his risk averseness and given his utility function; the owner may reject the project in spite of its positive ENPV.