Capital Budgeting and the Stochastic Cost of Capital

Despite its shortcomings, the IRR method continues to be a widely employed evaluation technique in capital budgeting. This paper demonstrates the reasons for its continued popularity. Specifically, the non‐requirement of a discount rate is suggested to be an important factor in the choice of IRR over the NPV criterion. A major implication is that managers face a very elusive, or stochastic, discount rate for NPV analysis. Thus, the aversion to NPV may go beyond simple aesthetics.