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Investment decisions, net present value and bounded rationality

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Author Info
Magni, Carlo Alberto

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Abstract

TThe Net Present Value maximizing model has a respectable ancestry and is considered by most scholars a theoretically sound decision model. In real-life applications, decision makers use the NPV rule, but apply a subjectively determined hurdle rate, as opposed to the “correct” opportunity cost of capital. According to a heuristics-and-biases-program approach, this implies that the hurdle-rate rule is a biased heuristic. This work shows that the hurdle-rate rule may be interpreted as a fruitful strategy of bounded rationality, where several domain-specific and project-specific elements are integrated and condensed into an aspiration level. The paper also addresses the issue of a productive cooperation between bounded and unbounded rationality.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 6073.

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Date of creation: Aug 2007
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Handle: RePEc:pra:mprapa:6073

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Related research
Keywords: Finance; Investment decisions; Net Present Value; heuristics; bounded rationality; cognition.;

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Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
B40 - Schools of Economic Thought and Methodology - - Economic Methodology - - - General
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
A12 - General Economics and Teaching - - General Economics - - - Relation of Economics to Other Disciplines
M20 - Business Administration and Business Economics; Marketing; Accounting - - Business Economics - - - General
G30 - Financial Economics - - Corporate Finance and Governance - - - General

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Andrew B. Abel, 1988. "Consumption and Investment," NBER Working Papers 2580, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Magni, Carlo Alberto, 2004. "An alternative approach to firms’ evaluation: expert systems and fuzzy logic," MPRA Paper 7879, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  3. John Graham & Campbell Harvey, 2002. "HOW DO CFOs MAKE CAPITAL BUDGETING AND CAPITAL STRUCTURE DECISIONS?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 15(1), pages 8-23. [Downloadable!] (restricted)
  4. Lawrence H. Summers, 1987. "Investment Incentives and the Discounting of Depreciation Allowances," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 295-304 National Bureau of Economic Research, Inc. [Downloadable!]
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  5. Carlo Alberto Magni, 2009. "A fuzzy expert system for solving real-option decision processes," Documentos de Trabajo 005677, UNIVERSIDAD TECNOLÓGICA DE BOLÍVAR. [Downloadable!]
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  6. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February. [Downloadable!] (restricted)
  7. Ravi Jagannathan & Iwan Meier, 2002. "Do We Need CAPM for Capital Budgeting?," Financial Management, Financial Management Association, vol. 31(4), Winter.
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  8. Ortmann, Andreas & Gigerenzer, Gerd & Borges, Bernhard & Goldstein, Daniel G., 2008. "The Recognition Heuristic: A Fast and Frugal Way to Investment Choice?," Handbook of Experimental Economics Results, Elsevier. [Downloadable!] (restricted)
  9. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May. [Downloadable!] (restricted)
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