Capital Budgeting Essay

1412 Words Feb 15th, 2012 6 Pages
Capital Budgeting Essay
(Derived from Chapter 17: Long-Term Investment Analysis)
Title: The Lorie-Savage Problem

BUS 505 – Multinational Economics of Technology

Table of Contents
1.0 Introduction – Lorie-Savage Problem 3
1.1 Thesis Statement 3
2.0 Supporting Research 4
3.0 Conclusions and Recommendations 6
References 7

1.0 Introduction – Lorie-Savage Problem The Lorie-Savage problem is a problem introduced in 1955 that addresses the issue in how to allocate capital (or resources) among competing investment opportunities with constraints on the available resources. (Lorie & Savage, 1955, p. 229) In defining this problem, Lorie-Savage structures it by outlining three separate scenarios:
1) Given the cost of
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(Huang, 2008, pp. 35, 45) These are only a few of the extensions researched on the solutions of IRR, NPV and genetic algorithms in helping to solve the capital budgeting dilemma in terms of which technique is the best to use. This is a rigorous debate with no clear cut answer. Osbourne states that NPV is super to the orthodox IRR method; all while making no mention of the advantages MIRR has over both. (Osbourne, 2010, p. 238) (Kierulff, 2008, p. 328) One of the premier textbooks in the area of finance titled “Principles of Corporate Finance” by Brealey, Myers, and Allen, states the IRR is misleading due to the fact that managers may make a decision based on the largest discount rate and not the largest NPV. (Brealey, Myers, & Allen, 2008, p. 130)

3.0 Conclusions and Recommendations While there is no clear answer, it is widely accepted that IRR is the least advantageous when compared to the other methods. Yet IRR is highly likely to continue to be used by executives and managers due to their general familiarity with IRR (as well as their client’s familiarity). (Brown, 2006, p. 5) What a finance professional should take from this topic is that he/she needs to realize and accept that there is no general solution to the issue of which method is best to use to make the decision(s) on how “to ration available capital or liquid resources among competing investment

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