Capital Budgeting with Unspecified Discount Rates

Øyvind Bøhren · Terje Hansen

28 citations0/0 files storedScandinavian Journal of Economics

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Capital Investment and Risk Analysis Multi-Criteria Decision Making Decision-Making and Behavioral Economics

Abstract

Public or private allocation problems often involve numerous multiperiod decision alternatives, conflicting preferences, or imperfect knowledge about decisionmakers' wants. By placing only weak restrictions on permissible preferences, very simple cashflow characteristics are used in this paper to select most-preferred projects for any individual within the general class. Judging from an empirical test, the approach seems powerful in terms of simplifying complex capital budgeting problems. For instance, presupposing that discount rates are positive and constant over time, 26 out of 30 mutually exclusive projects could immediately be disregarded by every individual, regardless of what specific value is taken on by this discount rate.

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References

1964CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK*1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]1972Capital Market Equilibrium with Restricted Borrowing 1959Theory of Value 1960Stationary Ordinal Utility and Impatience 1975Optimal rules for ordering uncertain prospects 1958On the Theory of Optimal Investment Decision 1977Risk-adjusted discount rates and capital budgeting under uncertainty

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