BEC Custom 7 Flashcards
Capital Budgeting
the process of measuring, evaluating, and selecting long-term investment opportunities for a firm
Risk (in reference to project risk)
the possibility of loss or other unfavorable results that derives from uncertainty implicit in future outcomes
Reward
the benefit expected or required from investment of resources in capital projects and other undertakings
Payback Period Approach
Determines the number of years needed to recover the initial cash investment in a project and compares that time with a pre-established maximum payback period
*ignores time value of money
Discounted Payback Period Approach
Determines the # of years needed to recover the initial cash investment in a project using discounted cash flows and compares that time with a pre-established maximum payback period
Accounting Rate of Return Approach (ARR)
- determines the expected annual incremental accounting net income from a project as a percent of the initial (or average) investment
ARR Formula
average annual incremental revenue - average annual incremental expenses / initial (or average) investment
*accrual accounting
Net Present Value Approach (NPV)
Determines the present value of expected cash inflows and compares that value with the present value of expected outflows in the project
*present value is determined using discount rate, also called “hurdle rate”, based on cost of capital to firm (WACC)
Internal Rate of Return Approach (IRR)
Determines the discount rate that equates the present value of expected cash inflows with the present value of expected cash outflows
*IRR computes the discount rate that makes the NPV of cash flows equal to zero
Profitability Index Approach (PI) - Cost Benefit Ratio
Determines project rankings by taking into account both the net present value and the cost of each project
Profitability Index calculation
PI = NPV of project inflows/PV of project cost
Financial Structure
The mixture of liabilities and owners’ equity accounts of a firm
Capital Structure
The long-term sources of funding - long-term debt and owners’ equity
Short-term or Working Capital Financing
The funding provided by obligations which become due within one year (i.e. current liabilities)
Payables
Occur through the acquiring of goods or services financed by incurring an obligation to pay in the future
Accrued Accounts Payable
Result from acquiring cash and other benefits financed by an obligation to be financed in the future
“Stand-by” credit
An arrangement to have financing available for a specific purpose or period of time
Line of credit
Informal agreement whereby a financial institution agrees to a maximum amount of credit that will be extended at any one time
Revolving credit
formal agreement whereby a financial institution or other lender agrees to a maximum amount of credit that will be extended
Letter of credit
A conditional commitment by a financial institution to pay a third party in accordance with specified terms and conditions
Commercial Paper
short-term, unsecured promissory notes sold by large, highly-creditworthy firms
Pledging Accounts Receivable
using accounts receivable as security for short-term borrowings
Factoring Accounts Receivable
Factoring is the sale of Accounts Receivable
- buyer is called the “Factor”
Without recourse
The factor (buyer) bears the risk associated with collectability, expect in the case of fraud
