Investment decisions, net present value and bounded rationality

Carlo Alberto Magni

Quantitative Finance, 2009, vol. 9, issue 8, 967-979

Abstract: The Net Present Value maximizing model has a respectable ancestry and is considered by most scholars to be 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.

Keywords: Corporate finance; Investments; Bounded rationality; Valuation; Cognition and economics (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (8)

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DOI: 10.1080/14697680902849338

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