Rational Capital Budgeting in an Irrational World
J. OF BUSINESS, Vol. 69 No. 4, October 1996
Posted: 15 Jan 1997
This article addresses the following basic capital budgeting question: Suppose that cross-sectional differences in stock returns can be predicted based on variables other than beta (e.g., book-to-market), and that this predictability reflects market irrationality rather than compensation for fundamental risk. In this setting, how should companies determine hurdle rates? I show how factors such as managerial time horizons and financial constraints affect the optimal hurdle rate. Under some circumstances, beta can be useful as a capital budgeting tool, even if it is of no use in predicting stock returns.
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation