ABSTRACT
The traditional economic theory of the investment decision has gained widespread acceptance in spite of its failure to deal adequately with risk. Under conditions of complete certainty, perfect capital markets and rational, wealth-maximizing behavior, the central, normative proposition in the micro-theory of investment can be stated as “… the firm should adjust its capital stock until the marginal rate of return on further investment (or disinvestment) is equal to the cost of capital” [20, p. 333]. Since, by these assumptions, there can exist one and only one rate of interest for any holding period, and since it is assumed that all future cash flows are fixed, the solution is both well-known and relatively straightforward. Discount rates can be employed, discounting operations performed, and instructive comparisons made between accounting rates of return, payback periods, internal rates of return, present value indexes, and the net present value discounted at “the cost of capital.” More often than not, the comparison ends with an observation about the generality of the last-mentioned method, and about the relative weaknesses of the rest.
