Lecture_cap_bud - ORIE 350 November 16, 2006 Capital...

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ORIE 350 November 16, 2006 Capital Budgeting
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Notes Ordinary final exam is Dec. 14 No section at all next week Lecture on Tuesday No lecture on Thursday! Office hours will be as usual.
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Capital Budgeting The process of making capital expenditure decisions is known as capital budgeting. We’ll modify the textbook presentation slightly. We will focus only on screening decisions: whether a proposed project meets some standard of acceptance. In contrast, preference decisions relate to selecting between several courses of action. This is more complicated, and will be left for ORIE 451/551.
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Capital Budgeting Topics We will cover only three simple topics: 1. Internal rate of return (IRR) 2. Payback period 3. Net Present Value (NPV) method
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IRR – Internal Rate of Return It is “Eye-are-are” not “urr” It represents the interest rate our investment earns. We purchase a machine for $130,000. It generates $15,000 in extra cash flow for ten years. Is this a good investment?
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IRR Many people like the IRR approach, as it tells them what they are earning on their investment in terms of percentage rate . Thus, much like what they get in a savings account or on the stock market.
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1. IRR – the interest rate that makes present value of future cash flows equal to the investment required today. . 2. If an investment has an IRR greater than our required interest rate (often called a hurdle rate ), then it is a good investment. 3. If a loan (or other borrowing) has an IRR less than our required interest rate (often called a cost of funds ), then it is a good loan. 4.
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Lecture_cap_bud - ORIE 350 November 16, 2006 Capital...

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