exam 4 Flashcards
Accounting Rate of Return (ARR)
A measure of profitability computed by dividing the average annual operating income from an asset by the initial investment in the asset.
Annuity
A stream of equal installments made at equal time intervals
Capital Budgeting
The process of making capital investment decisions. Companies make capital investments when they acquire capital assets—assets used for a long period of time.
Capital Rationing
Choosing among alternative capital investments due to limited funds.
Compound Interest
Interest computed on the principal and all interest earned to date.
Hurdle Rate
Management’s minimum desired rate of return on an investment; also called the discount rate and required rate of return.
Net Present Value (NPV)
The difference between the present value of the investment’s net cash inflows and the investment’s cost.
Discount Rate
Management’s minimum desired rate of return on an investment; also called the hurdle rate and required rate of return
Internal Rate of Return (IRR)
The rate of return (based on discounted cash flows) that a company can expect to earn by investing in a capital asset. The interest rate that makes the NPV of the investment equal to zero.
Payback Period
The length of time it takes to recover, in net cash inflows, the cost of a capital outlay.
Post-Audits
Comparing a capital investment’s actual net cash inflows to its projected net cash inflows.
Present Value Index
An index that computes the number of dollars returned for every dollar invested, with all calculations performed in present value dollars. It is computed as present value of net cash inflows divided by investment; also called profitability index
Profitability Index
An index that computes the number of dollars returned for every dollar invested, with all
calculations performed in present value dollars. Computed as present value of net cash inflows divided by investment; also called present value index
Required Rate of Return
Management’s minimum desired rate of return on an investment; also called the discount rate and hurdle rate.
Simple Interest
Interest computed only on the principal amount
Time Value of Money
The fact that money can be invested to earn income over time.
Future Value (FV)
The value at the end of any time span of concern.
Present Value (PV)
The value at the beginning of any time span of concern.
Payments (PMT):
A series of equal amounts spaced equally in time.
Interest Rate (i):
The rate that corresponds to the compounding period.
Time Period (n):
The number of compounding periods.
Compounding Period:
The frequency that interest is computed.
Single Sum Problems:
involve a single amount of money that either exists now or will in the future
Annuity Problems:
involve a series of equal periodic payments (spaced equally in time)
Ordinary Annuity (OA):
payments occur at the end of each period
Annuity Due (AD):
payments occur at the beginning of each period, STARTING TODAY!
Deferred Annuity:
payments occur in the future
Capital Assets
assets used for long periods of time, greater than one year.
- Examples: new equipment, factory, vehicles, information technology, intangibles (patents)
Capital Investments
when firms acquire capital assets
- The costs of acquiring long-lived assets said to be “capitalized.”
Capitalized:
means firms recorded the expenditure as an asset not an expense.
Cash Inflows:
when firm receives cash
* Proceeds from sale of old equipment
* Increased cash from customers
* Reduction in current operating expenses
* Cash proceeds from salvage value of equipment when project is complete
Cash Outflows:
when firm pays cash
* Initial investment
* Repairs and maintenance
* Increased operating costs
* Overhaul of equipment
