Corporate finance cap budgeting Flashcards
Average accounting rate of return
Over the life of a project, the AAR can be defined as the average net income divided by the average book value
Cannibalization
Cannibalization occurs when an investment takes customers and sales away from another part of a company
Capital Budgeting
The process that companies use for decision making on capital projects-those projects with a life of one year or more
Capital rationing
A capital rationing environment assumes the company that the company has a fixed amount of funds to invest
Conventional Cash Flow
A conventional cash flow pattern is one with an initial outflow followed by a series of changes inflows
Cost of Debt
The cost of debt financing a company, such as when it issues a bond or takes out a bank loan
Discounted payback period
The number of years it takes for the cumulative discounted cash flows from a project to equal the original investment
Externality
An effect of a market transaction that is borne by parties other than those who transacted
Hurdle rate
The rate of return that must be met for a project to be accepted
Incremental cash flow
The cash flow that is realized because of a decision; the changes or increments to cash flows resulting from a decision or action
Independent projects
Independent projects whose cash flows are independent of each other
Internal rate of return
The discount rate that make net present value = 0;
Mutually exclusive projects
Mutually exclusive projects compete directly with each other. For example if Projects A and B are mutually exclusive you can choose A or B
Net Present Value
The NPV of an investment cash inflows minus the present value of cash outflows
Non conventional Cash flow
In a nc cash flow patternC the initial outlfow is not followed by inflows only l, but the cash flows from positive (inflows) to negative (outflows) again (or even change signs several times)
Opportunity cost
The value that investors forgo by choosing a particular course of action; the value of something in its best alternative use
Payback period
The number of years required to recover the original investment in a project l. The payback is based on cash flows
Profitability index
For a simple project the PI is the present value of a projects future cash flows divided by the initial investment
Project sequencing
To defer the decision to invest in a future project until the outcome of some or all of a current project is known
Sunk cost
A cost that has already been incurred
Unlimited funds
An unlimited funds environment assumes that the company can raise funds rate it wants for all profitable projects simply by paying the required rate of return
