Chapter 5 Flashcards
All investments involve a trade off between _____ and ____
- Current Sacrifice
- Future Gain
Before investing, you need to know whether ______.
The future benefits are more than the current costs
Compounding is used when?
To compute the time it takes for an investment to double in value
What is the Rule of 72?
If you invest at a rate of return (r), divide 72 by r to get the number of years it takes to double your money
What are the 2 rules of discounting?
1) Discount and add up the future benefits of an investment
2) Compare them to current cost of the investment
Net Present Value (NPV) illustrates the link between ____ and _____.
Economic profit and Investment decisions
Economic profit measures what?
The true profitability of decisions
Projects with positive NPV create what?
Positive economic profit because they earn more than the company’s opportunity cost
What is the opportunity cost of capital?
When the company earns profit above what is required to pay its investors
The ____ is the discount that sets NPV equal to zero
Internal Rate of Return (IRR)
Over time, _____ or ____ can be created to give similar answers as NPV analysis
Shortcuts or Rules of thumb
What are two examples of shortcuts?
Payback periods and Breakeven Analysis
What is one con of Breakeven analysis?
Potential to give wrong answers because it ignores the time value of money
Do NOT use Breakeven Analysis to _____.
Justify higher prices or greater output
What is the basic business maxim?
Before investing, look ahead and reason back
