Investment decisions, net present value and bounded rationality

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

Abstract

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Finance, investment decisions, Net Present Value, hurdle rate, heuristics, bounded rationality, methodology
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity; A - General Economics and Teaching > A1 - General Economics > A11 - Role of Economics ; Role of Economists ; Market for Economists; D - Microeconomics > D4 - Market Structure, Pricing, and Design > D46 - Value Theory; A - General Economics and Teaching > A1 - General Economics > A12 - Relation of Economics to Other Disciplines; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C61 - Optimization Techniques ; Programming Models ; Dynamic Analysis; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M2 - Business Economics > M21 - Business Economics; B - History of Economic Thought, Methodology, and Heterodox Approaches > B4 - Economic Methodology > B41 - Economic Methodology

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