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Investment Selection with Imperfect Capital Markets

David G. Cantor
Steven A. Lippman

Abstract

How should corporate capital be allocated and which, if any, rules of behavior ought to guide business investment decisions? Much of the debate in the 1950's literature (see Solomon [18]) which set out to answer these questions focused upon choosing between the top two contending criteria for correct investment selection: present value and internal-rate-of-return. By invoking the assumption of perfect capital markets (see Hirshleifer [10]), the debate was essentially resolved in favor of present value. However, by dropping the perfect capital markets assumption and imposing a borrowing constraint, we characterize the relationship between an investment project's asymptotic (internal) growth rate and its set of internal-rates-of-return; this characterization resolves the debate in favor of the latter criterion.