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The Case of the Logarithmic Utility Function The Case of the Logarithmic Utility Function
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Taking Account of Preferences Toward Risk and Time Taking Account of Preferences Toward Risk and Time
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Taking Account of the Optimality of Consumption Growth Taking Account of the Optimality of Consumption Growth
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The Term Structure of Discount Rates The Term Structure of Discount Rates
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Summary of Main Results Summary of Main Results
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References References
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Cite
Abstract
This chapter examines a model in which the exogeneous rate of return of capital is constant but random. Safe investment projects must be evaluated and implemented before this uncertainty can be fully revealed, i.e., before knowing the opportunity cost of capital. A simple rule of thumb in this context would be to compute the net present value (NPV) for each possible discount rate, and to implement the project if the expected NPV is positive. If the evaluator uses this approach, this is as if one would discount cash flows at a rate that is decreasing with maturity. This approach is implicitly based on the assumptions that the stakeholders are risk-neutral and transfer the net benefits of the project to an increase in immediate consumption. Opposite results prevail if one assumes that the net benefit is consumed at the maturity of the project.
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