Chapter 10 Flashcards
capital
long term assets used in production
budget
a plan that outlines projected expenditures during a future period
capital budgeting
the whole process of analyzing projects and deciding which ones to accept and thus include in the capital budget
differences in security valuation and capital budgeting
stocks and bonds exist in the secuurities markets and investors chose from available set, most investors have no influence over the cash flows produced by their investments
Net Present Value
the present value of a projects cash inflows minus the present value of its costs, tells us how much the project contributes to shareholder wealth.
Larger NPV means
the more value the project adds and the higher the stock price
independent projects
those whose cash flows are not affected by other projects
mutually exclusive projects
two different ways of accomplishing the same result, so if one is accepted the other must be rejected
Internal Rate of Return
the discount rate that forces the PV of the inflows to equal the initial cost. the is equivalent to forcing NPV to zero. an estimate of the project’s rate of return, similar to ytm on a bond
Multiple Internal Rates of Return
if a project has nonnormal cash flwos (more than one sign change) then it has multiple IRRs.
Assumption of the NPV calculation
cash inflows can be reinvested at the projects WACC
IRR assumption
cash flows can be reinvested at the IRR
Why is assuming reinvestment at the WACC better
firms with good investments usually have access to debt and equity markets and can raise all of the capital it needs at the going rate, the WACC
problem with the IRR
overstates the expected return for accepted projects because cash flows cannot generally be reinvested at the IRR itself
Modified IRR (MIRR)
similar to the IRR but assumes that cash flows are reinvested at the WACC
