Chapter 10 Exam 4 Flashcards
process of evaluating and selecting long-term investments that are consistent with the firm’s goal of maximizing owner’s wealth.
Capital budgeting
most common type of investment, which includes property (land) and equipment; often referred to as earning assets
fixed assets
an outlay of funds by the firm that is expected to produce benefits over a period of time greater than 1 year.
capital expenditure
an outlay of funds by the firm resulting in benefits received within 1 year.
operating expenditure
five distinct but interrelated steps: proposal generation, review and analysis, decision making, _____ and _____
implementation and follow-up
Projects whose cash flows are unrelated (or independent to) on another; the acceptance of one does not eliminate the others from further consideration.
Independent projects
Projects that compete with one another so that the acceptance of one eliminates from further consideration of all projects that serve a similar function.
Mutually exclusive projects
Financial situation in which a firm is able to accept all independent projects that provide an acceptable return.
Unlimited funds
Financial situation in which a firm has only fixed number of dollars available for capital expenditure and numerous projects compete for these dollars.
Capital rationing
Two standard approaches to capital budgeting decisions.
Accept-reject and ranking approach
Evaluation of capital expenditure proposals to determine whether they meet the firms minimum acceptance criterion.
Accept-reject approach
Ranking of capital expenditure projects on the basis of some predetermined measure, such as the rate of return.
Ranking approach
Small and medium sized firms often use the ____ _____ approach to evaluate proposed investments.
Payback period
Amount of time required for a firm to recover its initial investment in a project as calculated from cash inflows.
Payback period.
If payback period is less than maximum acceptable payback period, ____ the project. If payback period is greater than the maximum acceptable payback period, _____ the project.
Accept, reject
Method used by most large companies to evaluate investment projects is the
Net present value
NPV is more ____ than the payback period because it takes the investors time value into consideration.
Sophisticated
PV of cash flows - initial investment
NPV
If the NPV is greater than $0, ___ the project. If the NOV is less than $0, ____ the project.
Accept, reject
Variation of the NPV rule. Found by taking the PV of cash inflows/initial cash outflow.
Profitability index
Companies using PI should invest if it is greater than ___
1.0
Profit above and beyond the normal competitive rate of return in a line of business.
Pure economic profits
Discount rate that equates the NPV of an investment opportunity with $0; it is the rate of return that the firm will earn if it invests in the project and receives the given cash inflows.
Internal rate of return (IRR)
If IRR is greater than the cost of capital, ____ the project. If IRR is less than the cost of capital, ____ the project.
Accept, reject
Graph that depicts a projects NPV’s for various discount rates.
Net present value profile
Conflicts in the ranking given a project by NPV and IRR, resulting from differences in the magnitudes and timing of cash flows.
Conflicting rankings
Cash inflows received prior to the termination of a project.
Intermediate cash inflows
On a purely theoretical approach, ___ is better approach to capital budgeting.
NPV
More than one IRR resulting from a capital budgeting project with a non conventional cash flow pattern; the maximum number of IRRs is equal to the number of sign changes in its cash flows.
Multiple IRRs
Capital budgeting is the process of
Evaluating a firms investment choices.
Unlike the IRR criteria, the NPV approach assumes an interest rate equal to the
Firms cost of capital
A conventional cash flow pattern associated with capital investment projects consists of an initial outflow followed by
A series of inflows.
The minimum return that must be earned on a project in order to leave the firms value unchanged is
The discount rate
One weakness of the payback period is that it
Ignores cash flows that occur after the end of the payback period.
The first step in the capital budgeting process is
Proposal generation
