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Investment decisions, net present value and bounded rationality

Magni, Carlo Alberto (2005): Investment decisions, net present value and bounded rationality.

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The 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 allegedly correct opportunity cost of capital. According to a euristics-and-biases-program approach, this implies that the hurdle-rate rule is a biased heuristic. This papers shows that the hurdle-rate rule may be interpreted as a fruitful strategy of bounded rationality, where several important element are integrated and condensed into an aspiration level. This paper also addresses the issue of a fruitful cooperation between bounded and unbounded rationality, of which the heuristic NPV is one significant example.

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