Capital Budgeting Issues (Investment Opportunity Schedule)
Every business firm is presented with numerous investment opportunities. Each opportunity can be incrementally ranked by Net Present Value (NPV) or Internal Rate of Return (IRR). Setting the cutoff point to accept or reject projects is a function of the marginal cost of capital. As you take on more capital, the senior debt, mezzanine lenders and equity partners want an increased return to compensate for the additional risk. Where these two curves intersect is the Investment Opportunity Schedule (IOS). Going beyond this point may add size to your organization, but actually it is detrimental to shareholder value.