Investment Decisions, Net Present Value and Bounded Rationality
Quantitative Finance, Vol. 9, No. 8, pp. 967-979, December 2009
24 Pages Posted: 3 Dec 2007 Last revised: 29 Jan 2010
Date Written: 2009
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 heuristics-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.
Keywords: Finance, investment decisions, Net Present Value, bounded rationality, hurdle rate, heuristic, methodology
JEL Classification: A11, A12, B41, C61, D46, D81, G11, G31, M21
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