An Investigation into the Decision Rules of Capital Investment Using Simulation

Abstract

The paper explores the effectiveness of the major decision rules commonly applied to the selection of investment alternatives. The rules are applied to a continual stream of simulated investments, as they arise period by period throughout the planning horizon. Thus the dynamics of investing now rather than later, with capital rationing, are taken into account. The practitioners' preference for the payback period is examined for a typical series of simulated investments, and the returns are compared against the returns of the more academically acceptable discounting decision rules. Particular attention is devoted to the benefits of each of the decision rules with reference to both risk and average returns.