On the Theory of Optimal Investment Decision

This article is an attempt to solve (in the theoretical sense), through the use of isoquant analysis, the problem of optimal investment decisions (in business parlance, the problem of capital budgeting). The initial section reviews the principles laid down in Irving Fisher's justly famous works on interest to see what light they shed on two competing rules of behavior currently proposed by economists to guide business investment decisions - the present-value rule and the internal-rate-of return rule. The next concern of the paper is to show how Fisher's principles must be adapted when the perfect capital market assumed in his analysis does not exist - in particular, when borrowing and lending rates diverge, when capital can secured only at an increasing marginal borrowing rate, and when capital is "rationed". Section III, which presents the solution for multiperiod investments, corrects an error by Fisher which has been the source of much difficulty.