The Maximum Prospective Value Criterion

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Abstract
In this paper the authors analyze the logic of the capital budgeting decision in two different settings. First it is assumed that the decision-maker has complete information about both his current and future investment opportunities in which case the decision problem reduces basically to a computing problem. Second it is assumed that the decision maker has complete information about his current investment opportunities and a knowledge of his expectations about future investment opportunities. The authors analyze the logic underlying the selection of the capital growth (discount) rate that should be used in determining whether a marginal increment of investment should be accepted or rejected. If the marginal increment were rejected, the unused cash would typically be invested temporarily in a highly liquid investment at a relatively low interest rate with the prospect that a better than marginal investment would absorb the funds at the next decision time. The analysis led to the formulation of a capital-budgeting decision criterion, called the Maximum Prospective Value Criterion, which is presented in this article. As its name implies, the criterion is designed to select the set of investments that has the maximum prospective value, given the decision-maker's expectations about his future investment opportunities. This criterion relates the capital-budgeting decision to the opportunity-cost and marginal-analysis concepts of classical economics. The present-worth criterion of engineering economy is shown to be a special case of the Maximum Prospective Value Criterion, and the minimum at tractive rate of return of engineering economy when properly selected appears to be closely related to the capital growth rate on the marginal increment of investment.

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