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Selection of a Minimum Attractive Rate of Return Click here for Streaming Audio To Accompany Presentation (optional) PowerPoint Presentation
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Selection of a Minimum Attractive Rate of Return Click here for Streaming Audio To Accompany Presentation (optional)

Selection of a Minimum Attractive Rate of Return Click here for Streaming Audio To Accompany Presentation (optional)

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  1. Selection of aMinimum Attractive Rate of ReturnClick here for Streaming Audio To Accompany Presentation (optional) EGR 403 Capital Allocation Theory Dr. Phillip R. Rosenkrantz Industrial & Manufacturing Engineering Department Cal Poly Pomona

  2. EGR 403 - The Big Picture • Framework:Accounting& Breakeven Analysis • “Time-value of money” concepts - Ch. 3, 4 • Analysis methods • Ch. 5 - Present Worth • Ch. 6 - Annual Worth • Ch. 7,7A,8 - Rate of Return (incremental analysis) • Ch. 9 - Benefit Cost Ratio & other methods • Refining the analysis • Ch. 10, 11 - Depreciation & Taxes • Ch. 12 - Replacement Analysis • Selection of the MARR EGR 403 - Cal Poly Pomona - SA16

  3. Selecting a MARR • MARR is generally the maximum of the: • Cost of borrowed money • Cost of capital • Opportunity cost EGR 403 - Cal Poly Pomona - SA16

  4. Sources of Capital • Money generated from the operation of the firm (retained profits and cash flow generated from depreciation). • External sources of funds: • Short term borrowing - banks (generally unsecured). • Long term borrowing - banks, insurance companies, pension funds, bonds (secured). • Permanent - sale of company stock. EGR 403 - Cal Poly Pomona - SA16

  5. Cost of Funds Cost of capital is the after tax weighted ROR of borrowed funds from all sources. EGR 403 - Cal Poly Pomona - SA16

  6. Investment Opportunities • There are many investment opportunities in an active firm and often limited capital. • Opportunity cost is the ROR of the best opportunity foregone. EGR 403 - Cal Poly Pomona - SA16

  7. Adjusting MARR to Account for Risk and Uncertainty • Increase MARR to avoid marginal projects. • Assess the projects using techniques other than economic analysis. Additionally, MARR might be adjusted to reflect imminent inflation. EGR 403 - Cal Poly Pomona - SA16

  8. Selecting a MARR • MARR is generally the maximum of the: • Cost of borrowed money • Cost of capital • Opportunity cost • If a project we are considering does not generate a greater return than these would cost, then we should put our money into these rather than the project. EGR 403 - Cal Poly Pomona - SA16

  9. Group Small project Large project Struggling Limited funds One year payback = 60 % ROR One year payback = 60 % ROR Stable Adequate funding Payback with a variable life 12 to 15% After-tax Representative Values of MARR Used in Industry In addition to these two factors,many other factors also affect interest rates: a public vs. a private organization, debt/equity position, risk posture, etc. EGR 403 - Cal Poly Pomona - SA16